“It has become clear to us and other regulators around the world that the marketing of research to clients as objective did not match reality”, according to the UK’s financial services regulator, the Financial Services Authority (FSA), in a policy paper in 2004 (04/06, paragraph 1.2). The investigations, particularly in the US, into the lack of impartiality in investment bank analysts’ reports in the dotcom boom of the 1990s has accordingly placed conflicts of interest within financial institutions firmly under the regulators’ spotlight. Despite there being limited regulatory action against UK-based analysts, in July 2004 the FSA introduced specific regulations aimed at preventing conflicts of interest affecting the independence of analysts’ work.
The spotlight has spread beyond analysts. There have been general rules on conflicts of interest since the advent in 1987 of comprehensive regulation of the financial services industry. The publicity surrounding analysts led the FSA to focus more closely on the wider issue. For example, on 17 September 2004, the FSA wrote to the chief executives of regulated firms reminding them of their responsibility to implement appropriate procedures for the effective risk management of conflicts of interest. The FSA said that firms could expect increasing scrutiny and challenge about their practices.
Financial institutions that have fiduciary obligations must also comply with the general law on conflicts of interest. Fiduciaries must not place themselves in a position where they may have a conflict of interest because doing so threatens the core obligation of a fiduciary, loyalty. Unlike the proactive role required of regulators, courts only act on the application of an aggrieved party. There has been relatively little judicial activity in this area as far as financial institutions are concerned but, with the renewed focus, it could be something that will concern the courts more in the future.
The starting-point for court action based solely on a conflict of interest is the existence of a fiduciary duty. This requirement limits the areas in which conflicts are relevant. If, however, there is a fiduciary duty, the law then imposes rigid obligations because of the special position accorded to fiduciaries.
The regulations enveloping the financial services industry expand beyond fiduciaries the areas where conflict rules apply, but they also offer more flexibility in order to try to meet the needs of modern financial institutions and their customers. The FSA’s philosophy is not to lay down detailed rules to cover all circumstances but, instead, to set out general principles and to impose on a regulated firm’s management an obligation to identify and manage conflicts in accordance with those principles. The rules allow, for example, Chinese walls (information barriers), something towards which the judiciary has traditionally displayed suspicion, if not hostility. There may, however, be signs that the regulatory acceptance of this tool is causing judges to be less dismissive of Chinese walls even if the legislation does not apply.
The applicable law is largely in the general law, described in outline below, in the Financial Services and Markets Act 2000 (FSMA) and in the rules made by the FSA under the powers given to it by FSMA.
The general rules made under FSMA
The FSA’s principle 8 states that a firm must manage conflicts of interest fairly, both between itself and its customers and between one customer and another. Conduct of Business Rule (COB) 7.1.3 goes on that if a firm has a relationship that may give rise to a conflict of interest in a transaction to be entered into with or for a customer or a conflict between customers, the firm must not knowingly advise or deal in the exercise of its discretion unless it takes reasonable steps to ensure fair treatment of a customer. Ensuring fair treatment may include disclosure of the conflict to the customer, establishing a Chinese wall, relying on a policy of independence or declining to act (COB 7.1.4).
Section 147 of FSMA expressly allows the FSA to make rules about Chinese walls. The FSA has done this in COB 2.4.4, which defines a Chinese wall as “an arrangement that requires information held by a person in the course of carrying on one part of its business to be withheld from, or not used for, persons with or for whom it acts in the course of carrying on another part of its business”. Reasonable steps must be taken to ensure that the Chinese wall remains effective and is adequately monitored.
Acting in conformity with a Chinese wall is a defence to proceedings under section 397(2) or (3) of FSMA (misleading statements and practices) and to proceedings for market abuse under section 118. Where something must be done “knowingly” for a rule to be breached, knowledge within an institution on one side of a Chinese wall will not be attributed to anyone on the other side of the wall (COB 2.4.6).
If a regulated firm is also a fiduciary (see below), it could be that it must comply with both common law rules and the FSA’s regulations. The FSA makes its rules under statutory authority, but it is not clear whether they supplant the common law (eg breach of the COB only gives a right of action to private investors, not to corporate clients: section 150 of FSMA). In practice, however, this will only be an issue in rare cases because compliance with the rules will in most instances meet the common law requirements. Reliance on a policy of independence has, however, no counterpart at common law (though it does involve disclosure to private customers but not others: COB 7.1.7) and therefore may be inconsistent with the common law if there is a fiduciary relationship.
The analysts’ rules made under FSMA
In July 2004, the FSA imposed rules that apply where published investment research is held out as impartial or it is reasonable to assume that it is impartial (COB 7.16.5(1)). The rules are intended to ensure that analysts’ research reports are genuinely impartial (eg analysts do not recommend shares because their firm has underwritten an offering of those shares). Firms must establish a policy, appropriate to the firm, for managing effectively the conflicts which might affect the impartiality of the research, take reasonable steps to ensure that the policy is complied with, and make the policy available in writing on request (COB 7.16.5(2)).
The policy should cover, amongst other matters, the supervision of analysts, the remuneration of analysts, and the extent to which analysts can be involved in activities other than investment research (COB 7.16.5(3)). The FSA also offers more detailed guidance as to what should go in the policy (COB 7.16.7–7.16.15). For example, COB 7.16.11 says that the policy may allow a firm to use an analyst’s knowledge to identify business opportunities, but that it is likely to be inappropriate to use an analyst in a marketing capacity if this would give a reasonable perception of a lack of impartiality in his research. Trade bodies, such as the BBA, LIBA, ISMA and IPMA (collectively), and the Bond Market Association, have published papers offering guidance on appropriate policies to comply with COB 7.16.
Fiduciary obligations
There is no general law against holding a conflict of interest. If a conflict of interest leads, for example, to incorrect advice being given, the recipient of that advice may have a claim for breach of contract or in negligence or even deceit, but there is no claim merely because of the conflict.
The exception to this general principle concerns fiduciaries. Certain occupations have, by virtue of their status, been subject to fiduciary obligations (eg lawyers, agents, and directors). Others have fiduciary obligations imposed on them in particular circumstances only. The leading description of a fiduciary in this area is by Millett LJ in Bristol & West Building Society v Mothew [1998] Ch 1, 18, where he said:
“A fiduciary is someone who has undertaken to act for or on behalf of
another in a particular matter in circumstances which give rise to a
relationship of trust and confidence. The distinguishing obligation of a
fiduciary is the obligation of loyalty. The principal is entitled to the
single-minded loyalty of his fiduciary. This core liability has several facets. A
fiduciary must act in good faith; he must not make a profit out of his trust;
he must not place himself in a position where his duty and his interest may
conflict; he may not act for his own benefit or the benefit of a third person
without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary
obligations. They are the defining characteristics of the fiduciary.”
A fiduciary is not able to “manage” conflicts as required by the FSA’s principle 8. Instead the law requires that a fiduciary must avoid any position where his obligations to his principal may conflict with his personal interests or his obligations to someone else without the informed consent of all relevant parties. There does not have to be an actual conflict; it is enough that there is a reasonable apprehension of a potential conflict (Re Baron Investment (Holdings) Ltd [2000] 1 BCLC 272). A conflict of interest will, however, not necessarily be created by a fiduciary acting for and against the same client on two unrelated matters. There must be some reasonable relationship between the two matters, but they do not have to be the same (Marks & Spencer plc v Freshfields Bruckhaus Deringer [2004] 1 WLR 2331, 2335 and [2004] EWCA Civ 741 at [10]).
However, if it is obvious to the client that a person he instructs is in a position of conflict, the principal cannot complain (Kelly v Cooper [1993] AC 205). Nor can fiduciary obligations be prayed in aid to enlarge the scope of contractual duties (Clark Boyce v Mouat [1994] 1 AC 428, 437). The contractual position between two parties must, therefore, always be considered; contractual terms are important in regulating fiduciary duties.
Where a commercial counterparty has a clear interest in a transaction, there will seldom be an obligation of loyalty. It is possible, however, for there to be a fiduciary obligation that applies to one part of a relationship but not all (New Zealand Netherlands Society v Kuys [1973] 1 WLR 1126). In, for example, Ata v American Express Bank Ltd (17 July 1998), a bank entered into foreign exchange transactions with a client. It did not owe fiduciary duties generally. For part of the relationship, however, the bank had discretionary management of the client’s positions, and for that aspect it was held to owe fiduciary duties.
The duty of single-minded loyalty requires a fiduciary to respect his principal’s confidences. It also obliges a fiduciary to deploy whatever information he has in the promotion of his principal’s interests. As a result, if a fiduciary has obtained from one client, to whom he owes a duty of confidentiality, information which would help another client, the fiduciary has a conflict of interest such that he cannot do his duty to one client without being in breach of his duty to the other. The fiduciary cannot therefore act without the informed consent of both clients. Indeed, disclosing to one client information damaging to another without informed consent may breach a fiduciary’s duty even if the information is in the public domain because a fiduciary must not do anything likely to damage his client’s interests (Hilton v Barker Booth & Eastwood [2005] 1 WLR 567).
It is not difficult for a financial institution to be in a position where it has fiduciary obligations. For example, in United Pan-Europe Communications v Deutsche Bank [2000] 2 BCLC 461, the Court of Appeal decided that a bank with a deep relationship with a customer involving the disclosure of confidential business plans was a fiduciary (though the receipt of confidential information is not on its own enough to make someone a fiduciary: Arklow Investments v Maclean [2000] 1 WLR 594). The court granted an interim injunction to stop the bank bidding for a business in conflict with its customer.
Areas where fiduciary obligations may well be owed are, for example, discretionary investment management, and mergers and acquisitions work. In these, the client has an expectation that the institution will place the client’s interests above the interests of the institution and other clients. There would clearly be a conflict of interest if an investment bank were to act for two potential bidders for a takeover target, at least without the informed consent of both and an effective Chinese wall between the groups carrying out the work.
Confidential information
The obligation to avoid conflicts of interest continues whilst the fiduciary relationship is in existence. After the relationship has ended, the fiduciary ceases to be subject to the no conflict rule, but remains under an obligation to keep the principal’s information confidential. The principal is entitled to be protected from any avoidable risk of inadvertent disclosure or use of confidential information (Prince Jefri Bolkiah v KPMG [1999] 2 AC 222). The risk of disclosure must be real as opposed to fanciful, but it does not have to be substantial. If there is a real risk, the courts may prevent the former fiduciary exposing taking on an engagement to which that information is material.
Parties other than fiduciaries can owe obligations of confidentiality. An action for breach of confidence will succeed if the information in question is of a confidential nature, if it has been communicated in circumstances importing an obligation of confidence, and if unauthorised use is made of the information (Coco v AN Clark (Engineers) Ltd [1969] RPC 41, 47). There may also be contractual obligations of confidentiality. It is unclear whether the strictness of the rule in Bolkiah applies only to those who obtained information in a fiduciary capacity (or, perhaps, in circumstances giving rise to legal professional privilege) or whether it applies to all confidential information. If the latter, then the obligation is potentially onerous. The better view, however, may well be that the obligation of non-fiduciaries is not to misuse confidential information rather than not to create a risk that it may be misused.
The primary means of preventing improper use of confidential information is the establishment of a Chinese wall. In Bolkiah, the House of Lords might be taken to have said that only a pre-existing Chinese wall would be regarded as effective for these purposes. Subsequent case law (eg Young v Robson Rhodes [1999] 3 All ER 524) indicates that this is not correct and that an ad hoc wall can be permissible. An established wall will, however, carry more weight, and it is always necessary to show that a wall is actually effective.
Practical issues
Establishing policies to ensure the impartiality of analysts’ research is (in context) relatively straightforward. The issues are readily identifiable in the considerable number of papers (eg the FSA’s Consultation Papers 171 and 205, the FSA’s Policy Statement 04/05, the report of the International Organisation of Securities Commissions (IOSCO)’s technical committee on analysts’ conflicts (September 2003) and the papers by trade bodies referred to above). The FSA’s rules and guidance are relatively specific, and most major investment banks have summaries of their policies on their websites. Policies must be properly implemented and enforced.
Creating a general policy on conflicts of interest of all types is more onerous. The starting-point must be the identification of conflicts within a business, including where fiduciary duties could arise. For example, does private equity lead to a conflict with mainstream corporate finance work? Is there a conflict between acting as an adviser on an acquisition, acting as the agent for a syndicate lending to the acquirer, and entering into a derivatives deal related to the borrowing?
Only when conflicts have been identified can policies can be put in place to manage them. The policies are likely to include ensuring that clients with directly conflicting interests are not taken on or, if they are, that informed consent is obtained. It may also include Chinese walls between groups (or, in the case, for example, of a new joiner to a firm who may have material confidential information from her previous employment, between an individual and others in the same group). When establishing a Chinese wall it is necessary to consider training, physical separation of the individuals involved, securing electronic information, monitoring the wall’s effectiveness, procedures for crossing the wall, and disciplinary sanctions for breach.
Policies may also require clear terms of business setting out the obligations of a financial institution. The scope and content of fiduciary duties in particular can be significantly affected by contractual terms.
The FSA has only recently introduced new rules for analysts and put pressure on financial services companies to manage their conflicts more actively than might have been the case in the past. It will take time for this regulatory activism to bed down. The FSA is, however, likely to want to be satisfied that steps have been undertaken to address conflicts seriously and effectively, failing which disciplinary measures could follow.
The FSA’s rules can be found at http://www.fsa.gov.uk. The recommendations of the trade bodies referred to above are also on their websites.
The main conflict issues faced by auditors differ from those in the financial services and legal sectors. Auditors must, like others, avoid conflicts of interest between two clients or between themselves and a client. However, the main issue is the circumstances in which an auditor’s relationship with the management of the company jeopardises, or might be perceived to jeopardise, his ability to report objectively to shareholders on whether the company’s accounts give a true and fair view of the state of affairs of the company. To undertake this work, an auditor must be independent of the company. The collapse of Enron, the subsequent collapse of its auditors (Andersen), and later corporate problems (eg Parmalat and Ahold), led some to question whether auditors could become too close to the companies they audit.
Auditors are generally appointed by shareholders in general meeting. The UK’s approach has been to provide information to shareholders to enable them to decide whether the company’s auditors are sufficiently independent and, as far as quoted companies are concerned, whether the company is complying with the principles of good governance. This has entailed, for example, requiring greater disclosure by auditors of non-audit fees.
The UK has also reorganised supervision of the accounting bodies to which auditors must belong by creating a new regulator, the Financial Reporting Council (FRC), to provide independent oversight of accounting standards and ethics. One of the FRC’s operating bodies, the Auditing Practices Board (APB), has issued ethical guidance which the accountancy professional bodies have agreed that their members must follow. The FRC has also updated the Combined Code on corporate governance. The Combined Code requires quoted companies either to appoint an audit committees to make recommendations about the appointment of auditors and to monitor auditors’ independence or to explain why they have not done so.
If auditors fail in their duties, whether as a result of a lack of independence or otherwise, they can be disciplined by their professional bodies or, in some cases, the FRC, and also sued through the courts by their audit clients for losses caused by the auditors’ negligence.
Cadbury and Greenbury, Hampel and Higgs, to name but a few. In response to major corporate failures, the last 15 years or so has seen a series of reports on corporate governance, particularly within quoted companies. The collapse of Enron in 2002 brought a further spate of reports focused specifically on the role of auditors (Smith, the Co-ordinating Group on Audit and Accounting Issues (CGAAI), the Review of the Regulatory Regime of the Accounting Profession, IOSCO, and the European Commission, to name but a few more of the reports).
The more recent reports were concerned primarily with the independence of auditors and, in particular, whether auditors should be barred from activities that might jeopardise their independence. This scrutiny of auditors’ activities outside the confines of auditing was undoubtedly a factor persuading three of the four big four accounting firms to separate their consulting and auditing practices.
The law governing the requirement for companies to have auditors is in the Companies Acts 1985 and 1989 (as amended by later legislation). The UKLA’s Listing Rules and the Combined Code impose additional disclosure requirements in relation to corporate governance. The FRC acts as an independent regulator of the professional organisations to which auditors must belong. The FRC has five further operating bodies, including the APB and the Accountancy Investigation and Discipline Board (AIDB), which deals with disciplinary cases that raise important issues affecting the public interest. Other disciplinary cases are dealt with through the professional organisations themselves, such as the Institute of Chartered Accountants in England and Wales (ICAEW).
All companies must have an auditor, subject to certain exemptions for smaller private companies (section 384 of the Companies Act 1985 (CA 1985)). The size limit for smaller companies includes, for example, a turnover of less than £5.8 million and a balance sheet total of not more than £2.8 million (section 249A(3) of CA 1985). The auditors must report to the company’s shareholders on whether the accounts have been properly prepared and give a true and fair view of state of affairs of the company (section 235 of CA 1985).
Auditors are appointed annually by the shareholders in general meeting, though private companies can in certain circumstances dispense with annual appointment (sections 385–386 of CA 1985). If the company wishes to remove or not reappoint an auditor, there are special protections including, for example, that an auditor is entitled to notice of the resolution to remove him and to make representations that must be sent to shareholders (sections 391 and 391A of CA 1985). An auditor who resigns may also lodge of statement of any circumstances which he feels should be brought to the attention of the shareholders.
Auditors must be properly qualified, which in practice means membership of one of the recognised accountancy bodies, such as the ICAEW (section 25 of the Companies Act 1989). Since the task of an auditor is to report to shareholders on the management, they must be independent of management. An officer or employee of a company is, accordingly, not eligible for appointment as auditor (section 27 of the Companies Act 1989). This requirement of formal independence is, however, the least that can be expected. Greater risks flow from the more intangible factors that are covered not by legislation but by the accountancy bodies’ professional rules, which require compliance with the APB’s Ethical Standards (ES).
The APB requires audits to be conducted with integrity, objectivity and independence (ES1, paragraph 6). Objectivity is a “state of mind that … requires that the auditors’ judgment is not affected by conflicts of interest” (paragraph 9). Independence is “freedom from situations and relationships which make it probable that a reasonable and informed third party would conclude that objectivity either is impaired or could be impaired” (paragraph 12). Auditing firms are required to establish a strong control environment, including designating an “ethics partner”, and to monitor areas such as economic dependence on clients, the performance of non-audit services, and audit partner rotation (paragraphs 20 and 21).
The threats to objectivity and independence identified by the APB include the “self-interest threat”, for example, financial interest in the client, the “self-review threat”, where the results of non-audit work are reflected in the amounts included in the company’s accounts, and the “management threat”, where the auditor takes management decisions within the company. For example, the design and implementation of information technology creates self-review and management threats to an auditor’s independence (ES5, paragraph 48).
The APB is also concerned with the “familiarity (or trust) threat”, ie long association with the client’s management leading to insufficient questioning (ES1, paragraph 28). The APB does not require companies to rotate their auditors in order to avoid this, but it does provide that no one should act as audit engagement partner for a listed company for a continuous period of more than five years, and other senior staff should not act for longer than seven years (ES3, paragraphs 12, 16, and 17). For unlisted companies, monitoring is required, and after a continuous period of 10 years, careful consideration of the engagement partner’s position is required to avoid the perception of lack of independence.
Valuation, tax, litigation support, legal and corporate finance services can all threaten the independence of an auditor (ES5). The APB does not ban auditors carrying out non-audit work for audit clients because of the benefits familiarity can bring, both to auditing and to consulting. Instead, auditors must assess whether any particular non-audit work threatens their independence and whether there are any safeguards that could eliminate the threat or reduce it to an acceptable level (ES5, paragraph 12). The total fees from a listed client should not exceed 10 per cent of the annual fee income of the audit firm, or 15 per cent in the case of a non-listed client, in order to avoid excessive economic dependence on a client (ES4, paragraphs 23 and 24).
A company’s annual report must state how much auditors have been paid for their work, both audit and non-audit (sections 390A and 390B of CA 1985; the Government has recently consulted on draft regulations made under those sections). Shareholders can therefore judge whether the work undertaken by auditors might jeopardise their independence.
Following a report by Sir Robert Smith for the FRC, the Combined Code recommends that listed companies should establish an audit committee of three independent non-executive directors. The audit committee’s role includes putting recommendations to the board, for it to put to shareholders, about the appointment and removal of auditors, and approving auditors’ remuneration and terms of engagement (paragraph C3.2). The audit committee should also review and monitor the auditor’s independence and objectivity, and develop and implement a policy on the supply by the auditor of non-audit services. Paragraph 12.43A of the UKLA’s Listing Rules requires quoted companies to state in their accounts whether they have complied with these provisions of the Combined Code and, if not, give reasons for non-compliance (“comply or explain”).
Auditors who offend the principles about independence and objectivity can be disciplined by their professional body or, in cases of public interest, by the AIBD. An auditor also owes a duty of care in tort to the company he audits (and probably contractual duties too), which cannot be excluded (section 310 of CA 1985). An auditor is liable to a company for losses suffered as a result of a negligent audit, but only has a limited area of liability to shareholders, absent special circumstances. The purpose of an audit is to enable shareholders to exercise their class rights in general meeting, and does not extend to investment decisions by shareholders (Caparo Industries plc v Dickman [1990] 2 AC 605). Shareholders cannot therefore in general claim against auditors as a result of decisions made on the strength of audited accounts to buy or hold shares. If, however, a company is successful in recovering losses suffered as a result of an auditor’s negligence, that will redound to the benefit of the shareholders.
The CGAAI commented that, as a result of the earlier reports on corporate governance, the UK had a “sophisticated and effective system of oversight … to the extent that the UK can claim, with some justification, to be at the forefront of best practice”. It also commented that, for example, whilst there was little clear support for the view that non-audit work in fact compromised an auditor’s independence, it raised significant concerns as to the appearance of independence, which needed to be addressed. These concerns have been addressed though legislative and other changes, which either have come into force or do so over the course of 2005.
The outlook probably depends upon whether there are any further corporate failures that focus attention on the effectiveness of auditors. Absent further scandal, it seems time is required to assess whether the current position is satisfactory or whether further reform is necessary.
The FRS’s website (http://www.asb.org.uk/) has details of its role and activities and the APB’s ethical standards, as well as links to the CGAAI and other reports. The Combined Code is on the UKLA’s website at http://www.fsa.gov.uk/pubs/ukla/lr_comcode2003.pdf, and the ICAEW’s site (http://www.icaew.co.uk/) has its ethical and other guidance.
Lawyers are fiduciaries. They must not act for two parties whose interests conflict without the informed consent of both. Further, even when the fiduciary relationship has ceased, lawyers must ensure that clients’ confidential information is protected from any avoidable risk of inadvertent disclosure or use.
The position is now overlaid by the new rules issued by the professional body for solicitors, The Law Society (these rules were approved by the Society in 2004, and are due to come into effect imminently). These rules will take effect as statutory instruments under legislative powers given to The Law Society. Where these new rules are stricter than the general law relating to fiduciaries, solicitors must comply with the stricter rules. In those small number of places where the rules are less strict, prima facie they change the general law as far as solicitors are concerned. There may, however, be an issue whether the authority given to The Law Society by statute enables it to relax the law.
If a lawyer acts in breach of his duties with regard to conflicts of interest, a complaint can be made to The Law Society. Action can also be taken through the courts to seek an injunction to restrain lawyers from breaching their obligations.
The new rules inevitably mean that there will be a renewed focus on conflicts of interest. The old rules, which did not have statutory effect, were both confused and confusing, with firms reasonably taking different views as to what they required. The new rules represent a new regulatory start, and The Law Society may well wish to be more active in ensuring compliance.
England and Wales
Solicitors have traditionally been subject to the law relating to fiduciaries, which developed in a different commercial age. Changes in business have brought new challenges. For example, following the repeal in 1967 of the law that limited solicitors’ partnerships to 20 partners, firms have grown enormously. Clients have also become less wedded to the use of particular law firms. These challenges were made more difficult by the uncertainty in The Law Society’s rules and, indeed, in the general law. In 2000, the City of London Law Society published a report suggesting reform, and in 2004 The Law Society approved new rules. These rules are not in general aimed at easing the rules for large firms (the rules are often stricter than those they replace), but at providing greater certainty as to what the rules require.
See above.
Fiduciary obligations
Solicitors are fiduciaries, and must therefore comply with the general law in this area, subject to the effect of The Law Society’s new rules. The general law is summarised at section A.4 above, but is well illustrated by Marks & Spencer plc v Freshfields Bruckhaus Deringer [2004] 1 WLR 2331 and [2004] EWCA Civ 741.
In that case, a firm of solicitors acted for M&S in a variety of matters but were not M&S’s main corporate lawyers. They had acted in litigation, which provided them with extensive information about M&S’s supply chain, and in a number of commercial and employment matters. They were also continuing to act on contractual negotiations with an important supplier. The firm then started acting for a party which was considering making a takeover bid for M&S. The court granted an injunction, confirmed on appeal, against the solicitors to stop them acting on the takeover. The court considered that there was potentially a conflict of interest between acting for M&S on their contractual negotiations and against them on the takeover. It did not involve the same matter, but the negotiations were relevant to the takeover and, indeed, had been the subject of a due diligence question. Even if there had not been a current conflict of interest, the solicitors held confidential information relevant to the bid. The court refused to accept that a Chinese wall could protect that confidential information because of the very large number of people who had relevant information.
In general terms, for a Chinese wall to be accepted, the court must be satisfied that effective measures have been taken to ensure that no disclosure of confidential information will occur (Prince Jefri Bolkiah v KPMG [1999] 2 AC 222, 238–239). This requires that electronic and hard copy information is safeguarded, but the prime issue that has concerned the courts is whether there must be physical separation between the people who hold the information and those to whom it may be relevant. In some cases the courts have insisted on this (eg Halewood International v Addleshaw Booth & Co (unreported, 5 November 1999), but in others they have not (eg Koch v Richards Butler [2002] 2 All ER (Comm) 957).
The Law Society’s new conflict rules
The Law Society is amending its rules with regard to conflicts of interest (though these new rules do not apply to conflicts in relation to conveyancing, property selling, or mortgage-related services).
The Solicitors’ Practice (Conflict) Amendment Rule (the Conflicts Rule) will, when it comes into force, confirm the principle that solicitors must not act if they have a conflict of interests (paragraph 2(a)). A conflict of interest occurs in two situations: where solicitors owe separate duties to act in the best interests of two or more clients in relation to the same or related matters, and there is a significant risk that those duties may conflict; and where there is a significant risk that the solicitors’ duty to act in the best interests of any client in relation to a matter may conflict with the solicitors’ own interests in relation to that or a related matter (paragraph 2(b)).
There are three main exceptions to the general rule against acting where there is a conflict of interest. Paragraph 3(a) of the Conflicts Rule allows solicitors to act for two or more clients who have substantially the same common interest in relation to the matter. All clients must give their informed consent in writing, and it must be reasonable to act for more than one client. The guidance notes say that this applies when it would be disproportionate in terms of cost and general disruption to require clients to instruct different solicitors, and there is a clear common purpose and a strong consensus on how it is to be achieved.
Paragraph 3(b) of the Conflicts Rule allows solicitors to continue to act if two or more clients are competing for the same asset, if there is no other significant conflict between them, if different individual solicitors act for each client, if they have given their informed consent in writing, and if it is reasonable to act. The guidance notes say that this exception applies in specialist areas, such as acting on insolvencies for two or more creditors, or for competing bidders, or those funding competing bidders, for privately owned businesses being sold by auction. The rule is intended to be sufficiently wide to permit commercial transactional work where clients can give informed consent, but The Law Society counsels against seeking to make use of the rule where it is not already accepted business practice.
The final exception applies where a solicitor is already acting for a client, and a conflict arises during the course of a matter. In those circumstances, the solicitor may only continue to act for one of the clients provided that the duty of confidentiality to the other clients is not put at risk.
The Law Society’s new confidentiality rules
The Law Society is also amending its rules as regards confidentiality. The Solicitors’ Practice (Confidentiality) Amendment Rule (the Confidentiality Rule) will, when it comes into force, confirm the principle that a solicitor must keep the affairs of clients and former clients confidential (paragraph 2).
The Confidentiality Rule also reiterates the obligation of fiduciaries to disclose to a client all information of which the solicitor is aware which is material to the client’s matter regardless of the source of that information (paragraph 3). It does, however, provide exceptions to this general principle, some of which are uncontroversial (eg where disclosure is prohibited by law or the client expressly agrees to limited disclosure), but one of which may cause difficulties.
Paragraph 3(i) allows a solicitor to withhold material information from a client if “there is a duty of confidentiality [to another client], which always over-rides the duty to disclose”. The wording of this is unclear. Arguably, it only applies if there is a duty of confidentiality to one client which, as a matter of law, overrides the duty to disclose. If so, it will have little application because a duty of confidentiality owed to one client does not override the duty to disclose information to another. The solicitor has irreconcilable duties and cannot comply with one without being in breach of the other, but one duty does not override the other (Hilton v Barker Booth & Eastwood [2005] 1 WLR 567, 570 and 578).
However, the guidance notes indicate that paragraph 3(i) is intended to mean that a duty of confidentiality to one client will override a duty of disclosure to another client. If so, it embodies the law as stated by the Court of Appeal in Hilton v Barker Booth & Eastwood [2002] Lloyd’s Rep PN 500 but which was subsequently overruled by the House of Lords ([2005] 1 WLR 567). The House of Lords reaffirmed that in these circumstances solicitors have a conflict of interest that prevents from them acting without the informed consent of both clients. This could raise the difficult issue of whether The Law Society has legislative authority to change the fiduciary obligations on solicitors. A cautious approach by solicitors is probably prudent.
Paragraphs 4 and 5 provide that where solicitors hold confidential information in relation to a client or former client, they must not risk breaching confidentiality by acting for another client who has an adverse interest and to whom that information might reasonably be expected to be material, unless both clients give their informed consent and it is reasonable to act. This is likely to require a Chinese wall, but it will depend upon what the safeguards the clients agree to.
Paragraph 6 also allows solicitors to continue to act on an existing matter, notwithstanding that they hold material information from another client, if it is not possible to obtain informed consent of all the clients. The client for whom the solicitor continues to act must give his informed consent and safeguards “which comply with the standards required by law at the time they are implemented [must be] put in place”. This will require a Chinese wall, with or without physical separation of the individuals involved, that the courts will accept as effective. The guidance contemplates that this rule could apply where it is not possible to obtain informed consent because enough information cannot be disclosed to the first client about the second or its business without breaching confidentiality.
The revised rules issued by The Law Society have been long in their genesis, but they are at least relatively clear, even if they could come into conflict with the general law about fiduciaries. There has been criticism of the position on conflicts of interest taken by some firms, particularly in the City of London, under the former rules, and it could be that The Law Society will feel it necessary to monitor the position more closely than it perhaps has done in the past. In any event, it remains open to any client who feels aggrieved to take the matter to the courts.
The Law Society’s website (http://www.lawsociety.org.uk/) contains its rules.
