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Related-party transactions and conflicts of interest. Standard 6 makes a distinction between related-party transactions and conflicts of interest. While some may argue that all related-party transactions are conflicts of interest, ECFA believes a useful contrast can be made to provide organizations with good decision-making guidelines. First let’s take a brief look at what constitutes a conflict of interest.
Conflicts of interest are situations in which a person has a responsibility for promoting one interest, but has a competing interest at the same time. When one exercises a competing interest over a fiduciary interest the conflict is realized. Examples of a realized conflict of interest include the following:
An organization's purchasing manager owns an interest in a travel agency through which the organization purchases airplane tickets and lodging reservations solely at the manager’s volition.
An organization’s board member also acts as legal counsel for the organization, recommending legal courses of action that will generate fees to the personal benefit of the board member's firm without the challenge of a competitive bid or second opinion. To mitigate this somewhat, the organization can prohibit the board member from voting on or approving such engagements. The difficulty in managing and controlling attorneys' time charges for only necessary work still presents the organization a major challenge in ultimately removing a conflict of interest. This example can apply to other professionals such as accountants, insurance agents, and architects.
An executive selects the airline and frequency of travel while personally accruing frequent flier miles on the selected airline. The conflict of interest is not in personally accruing frequent flier miles, but in acting without review or higher approval on the need for travel and on airline selection—especially if other carrier schedules and fares are more advantageous to the organization.
An employee, especially at a managerial level, pursues extracurricular activities—such as membership on boards and committees or other leadership roles in industry-related associations—so that substantial amounts of time, energy, or resources are diverted from the primary organization in which he or she is employed. In this situation, excessive amounts of extracurricular involvement are driven more by personal ambition than by benefit to the employing organization. While a conflict of interest is not always readily perceived, this type of situation can have serious implications for the employing organization; i.e., lost resources and dissemination of confidential information as a result of frequent contact with peers from other organizations.
These examples demonstrate that conflicts of interest are both obvious and subtle. The determining factor in each situation is the potentially inappropriate use of an organization's resources to benefit some competing interest. ECFA expects that member organizations will avoid conflicts of interest in their financial transactions.
Related-party transactions are transactions that occur between two or more parties (individuals, businesses, organizations, etc.) with inter-linking relationships. Sometimes these relationships can be benign: an organization buys a computer from a company that employs the wife of an organizational staff member—a staff member with no decision-making ability regarding the purchase. A more serious related-party transaction might occur if an organization purchased insurance coverage through a brokerage firm controlled by an organization’s board member. Additionally, if the purchase was not disclosed, was not approved appropriately, was not made at the best possible price or in the best interests of the organization, this example would also constitute a conflict of interest.
If an organization's board member or employee speaks at a function related to the organization, or speaks on behalf of the organization and receives an honorarium, this is a related-party transaction. While the precise facts and circumstances may assist in determining whether a conflict of interest has also occurred, it may be helpful for the organization to adopt a policy regarding the ownership of honoraria.
It is useful to think of related-party transactions as having the elements of an "arm's-length" transaction, while retaining a relationship of common control or interest among the parties. If true "arm's-length" elements do not exist in a related-party transaction then a conflict of interest occurs. In other words, a conflict of interest is a subset (only a part) of all the possible related-party transactions. While ECFA member organizations are to avoid conflicts of interest in their financial transactions, related-party transactions are permissible if they meet certain minimum criteria.
When evaluating minimum criteria, an organization should carefully examine all aspects of the transaction to ensure that no conflict of interest exists, even in subtle forms. The organization should also ensure that the financial transaction makes economic or sound business sense. Indeed, some related-party transactions are clearly advantageous to the economic benefit of an organization. Using the previously cited example of purchasing insurance coverage through a brokerage firm controlled by a board member, contracting with the firm may financially benefit the organization. If the coverage provisions are independently or competitively determined, and if the brokerage firm controlled by the board member elects to eliminate or significantly reduce its commission well below competitors’ bids, then it would be in the organization’s best interest to contract with the related party.
ECFA believes that related-party transactions may be appropriate in certain circumstances, if they can meet certain tests to ensure objectivity and are carefully evaluated to avoid conflicts of interest.
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