The question of how the financial industry in France deals with conflicts of interest is not one of how many rules and regulations there are to regulate it. Rather, the major issue raised by conflicts of interest within the financial industry, as in many other industries, is about making sure that one’s private business never drifts away from one fundamental commitment: where it is entrusted by client A with a given assignment, a financial institution must perform the assignment the best way it can without its own interests or the interests of another client, B, prevailing over the interests of that client A. This is what the Anglo-Saxon world refers to as a “fiduciary duty”, ie a duty of trust owed by any financial institution to each of its clients. And serving the interests of one client does not mean that one should be entitled to do everything. There is a limit, which is to refrain from causing harm to others. In this respect, the court battle between Morgan Stanley and LVMH, which is currently before French courts, has been (to our knowledge) the first opportunity in Europe to assess the circumstances and conditions under which an investment bank can be liable for financial research activities.
As to how it deals with conflicts of interest among financial institutions, French law does not, therefore, fundamentally differ from many other jurisdictions, since the rationale behind the rules adopted is the same, ie ensuring that the fiduciary duty is met and that one’s negligence does not cause harm. Unlike the meeting of the fiduciary duty itself, the liability aspect of conflicts of interest has been a focus of discussion because of the biased financial research activities carried out by large financial institutions around the world, primarily in the context of the Enron scandal.
To understand how French law and practice deal with the question of conflicts of interest in the financial industry, one should look at such question from three angles: a regulatory angle; a civil liability angle; and a criminal liability angle.
Like all the other EU jurisdictions, France has implemented conduct of business rules in line with the principles inserted in the 1993 Investment Service Directive, such principles being reflected in Article L 533–4 of the Financial and Monetary Code (FMC) since 1996. Among these rules there is the obligation for every investment service provider doing business in France, even on a mere cross-border basis, (i) to use its best endeavours to avoid conflicts of interest and, when they cannot be avoided, ensure that its customers are fairly treated, and (ii) to comply with all the regulations applicable to the conduct of its business so as to promote the best interests of its customers and market integrity.
In addition, as in many other EU jurisdictions, the number of regulations specifically dealing with conflicts of interest arising from financial research activities has grown, not only because the 2003 Market Abuse Directive makes it a duty for each EU member state specifically to regulate such conflicts, but also for fear of facing scandals similar to the Enron one, where it is believed some financial analysts painted an unrealistically rosy picture of certain issuers.
The FMC, the general regulations issued by the Autorité des Marchés Financiers (AMF) and the Civil Code are the main provisions dealing directly or indirectly with conflicts of interest in the financial industry.
As far as case law is concerned, a court battle is currently being fought before French courts, where Morgan Stanley, a big financial institution, is accused by LVMH, a luxury goods company, of producing biased and denigrating financial research to further the interests of one of its clients.
We will first look at the regulatory aspect of the question of conflicts of interest among financial institutions, and then at its civil and criminal liability aspects.
Recent developments have put a spotlight on financial research, while the general fiduciary duty owed by investment services providers has not, so far, raised major concerns.
General fiduciary duty owed by investment service providers
Articles 321–26 to 29 of the AMF General Regulations make it a duty for every investment services provider to appoint an independent compliance officer in charge of drafting a compliance manual providing for “Chinese walls” not only aimed at preventing any undue circulation of confidential information, but also at setting up the physical segregation of these activities the pursuit of which is likely to create potential conflicts of interest.
It is worth noting that the French regulator does not set out detailed conflicts of interest rules. It is up to each regulated entity, in accordance with its own specific needs, to adopt adequate conflicts of interest rules. This view does not, however, cover those conflicts of interest rules applicable to portfolio management companies. Such rules are indeed quite elaborate and numerous. They are mainly contained in Articles 322–31 to 322–52 of the AMF General Regulations.
Specific duties owed in case of financial research activities
Since 2001, additional rules specifically applicable to research analysts have been issued. These rules were added to in 2004, in the wake of the creation of the AMF in 2003 and with the view to implementing MAD.
A financial analyst is defined by Article L 544–1 of the FMC as any person who “carries on financial research activities if, as his usual business, he produces and distributes studies on legal entities making public offerings, with a view to producing and distributing opinions concerning the future prospects for such legal entities and, as the case may be, the likely fluctuations in the price of financial instruments issued by them”.
Independence, transparency and fairness are the key issues which the specific regulations on financial research activities focus on. Below are examples of such focus.
Financial analysts must not only act independently of other sensitive departments within their firm or group of companies, but also of the issuers themselves. The directors of an issuer must refrain from taking any action vis-à-vis financial analysts whom they pay for their services that would have the object or the effect of preferring their own interests or those of their shareholders to the detriment of fair information. Also, research analysts may not be compensated based upon specific investment banking services (eg underwriting or M&A transactions). And if research analysts are compensated from overall investment banking revenues, this must be disclosed in their research reports. In terms of Chinese walls, the need for financial analysts to remain independent from other sensitive departments or activities is reflected in the fact that a research analyst may not, without the consent of the Investment Research Supervisor (IRS), exchange information about a given transaction with any other employee of the group who provides placing and underwriting services, advises companies on capital structure, industrial strategy and related matters, or provides services in relation to mergers and acquisitions. And if a financial analyst has been brought over the Chinese wall, he may not resume his previous functions without the consent of both the compliance officer and the IRS.
Regarding transparency and fairness, the AMF has gone quite a way into setting out the qualities expected from financial research. Pursuant to the AMF General Regulations, the financial research must be done with probity, fairness and impartiality. It must be clear, accurate, and issued in time. In addition, financial institutions and their financial analysts must use their best endeavours to ensure that: (i) the facts referred to in the financial research are clearly distinguished from comments and any other non-factual items; (ii) all the sources used to produce the financial research are reliable or, in the negative, are referred to in the financial research as unreliable; (iii) all the major sources used to produce the financial research are referred to in the financial research; (iv) prospects and trading price objectives are clearly set out as such in the financial research, as well as the assumptions used; (v) where applicable, the financial research report refers to the fact that the financial research has been provided to the issuer and (as the case may be) that the financial analysts has amended his preliminary conclusions to take the issuer’s comments into account; (vi) the financial research report contains a summary of the methods and assumptions used to assess the value of a financial instrument or that of an issuer, and to choose the trading price objective; (vii) the financial research report adequately explains the meaning of any recommendation (on whether to buy, sell etc) and provides any appropriate risk warnings (including an assessment of how relative the assumptions used are); (viii) the expected frequency of updates on the financial research is published; (ix) any major change to the financial research policy of the provider is published; (x) the financial research clearly sets out the date on which it has been issued for the first time, as well as the day and hour corresponding to the trading price of the financial instrument referred to in the financial research; and (xi) any change of opinion occurring within 12 months, in respect of recommendations relating to the same financial instrument or the same issuer, is clearly set out in the financial research.
Civil and criminal liability issues relating to conflicts of interest
The breach of regulations by regulated entities does not automatically mean that they are liable to third parties or are carrying out criminal activities. Conversely, where a regulated entity complies with these regulations, or where there are no such regulations in force, this does not mean that the regulated entity keeps itself immune from civil and criminal liability. There is one simple rule under the French Civil Code: one is liable to a third party for the harm caused by one’s negligence (Article 1382). This is a rule applicable to all. So is Article L 465–2 of the FMC, under which a fine of up to €1,500,000 (or ten times the profits made, as the case may be) and at most two years’ imprisonment are imposed on those who, by any means, spread among the public false or misleading information (i) about the outlook for, or current situation of, an issuer of financial instruments traded on a regulated market or about the outlook for financial instruments traded on a regulated market, and (ii) which is likely to impact on the related trading prices.
France has hosted the first court case in Europe dealing with a conflicts of interest issue involving financial research activities. On 12 January 2004, the Commercial Court of Paris decided that Morgan Stanley had made false and denigrating statements in analyst reports and interviews regarding LVMH. It ordered the bank to pay €30 million to the luxury goods company and appointed an expert to assist the court to determine an amount of additional damages. This is the first securities case in France in which an investment bank has been held liable under tort law for breach of duties of independence, impartiality and rigour. Our purpose is not to take views on whether the claim of each party is legitimate. This is a matter still in the hands of the French judicial system. Our sole purpose is to underline the various possible grounds on which a financial institution such as an investment bank can be held liable for breach of its fiduciary duty.
From a regulatory standpoint, it should be noted that in the Morgan Stanley case, when the allegedly reprehensible facts took place, the regulatory framework now almost complete had not been adopted. In this respect, it should be noted now, that pursuant to Article 321–129 of the AMF General Regulations, a financial research report must refer to those relationships and circumstances which one should reasonably regard as affecting a financial analyst’s objectivity, eg where the financial institution or the financial analyst involved holds a significant stake in the financial instruments about which the financial research is done, or where there is a major conflict of interests between the financial institution or financial analyst involved and the issuer about which the financial research is done. Articles 321–130 and 321–131 of the AMF General Regulations are very specific as to the relationships and circumstances from which conflicts of interest are likely to arise and make it a duty for investment services providers to disclose such relationships and circumstances in the financial research. Now that the specific regulatory framework is available, it will be easier for the French regulator to take sanctions. One should, however, wonder whether the powers granted to the French regulators enable them to easily reach entities or persons located outside France, even though one of the purposes of MAD and the AMF regulations implementing it in the field of financial research is to have an extra-territorial scope.
From a civil liability standpoint, it is worth noting that there seems to be a consensus among legal writers that gross negligence is required in order to hold a financial institution liable for damages caused to third parties by biased and denigrating financial research.
From a criminal liability angle, it seems that prosecutors find it hard to prosecute financial institutions for the crime of market manipulation referred to in Article L 465–1 of the FMC, presumably because the article’s definition of market manipulation appears restrictive.
The AMF has still to issue more precise guidelines aimed at completing the already elaborate body of rules applicable to financial research activities. When the regulatory framework is complete, the AMF will certainly not hesitate to enforce it as much as it can.
Although MAD does not make it a requirement for EU member states to criminalise market manipulation acts, the French government is due to amend, in a near future, Article L 465–1 of the FMC to bring it into line with the definition of market manipulation provided for in MAD and now reflected in the AMF General Regulations. This will enable French prosecutors to prosecute financial institutions and their employees for market manipulation acts more easily than now.
The AMF rules can be found on the AMF’s website.
In France auditors (commissaires aux comptes) and chartered accountants (experts comptables) have separate professional organisations
France is one of the few countries where there are two separate professional structures, one for chartered accountants and the other for auditors. Chartered accountants are members of a Professional Association (Ordre), created in 1945, regulated by the Ministry of the Economy and Finance, whereas auditors are grouped to form a National Company (Compagnie), instituted by Decree in 1969 placed under the aegis of the Minister of Justice.
The distinction between the two structures is explained by the fact that in France the auditor’s task is defined by the law relating to the certification of accounts and he has obligations not only towards the company that is paying the fees, but also towards the authorities and the investors.
None the less, virtually all auditors are registered members of the Order of Chartered Accountants. On the other hand, not all chartered accountants necessarily apply for registration on the list of auditors, although more than 80% do so. Moreover, it should be noted that nearly one-quarter of the chartered accountants registered as auditors do not actually carry out auditing work.
In the remainder of this section we will refer solely to the rules concerning auditors.
The profession is basically regulated by the National Company of Auditors (Compagnie nationale des commissaires aux comptes, CNCC) and by the Regional Companies (Compagnies régionales, CRCC)
Only auditors registered on a special list have the right to certify companies’ accounts. It was the Law of 24 July 1966, reforming the Law relating to commercial companies, that for the first time prohibited persons who were not registered on a special list from acting as auditors.
A Decree dated 12 August 1969 then set up a body, the Compagnie nationale des commissaires aux comptes (CNCC), subdivided into 34 regional companies (CRCCs). The territorial authority of these regional companies is based on the territorial jurisdiction of the Courts of Appeal.
The CRCCs keep the lists of auditors. Registration is restricted to people with the necessary qualifications and of good standing. It is decided by commissions of seven members, chaired by a judge, in which auditors are not in the majority. When a candidate is registered on the list, he must swear an oath before the Court of Appeal promising to fulfil the duties of his profession with honesty and integrity and to ensure compliance with the laws.
Any person who acts as an auditor or uses the title of auditor who is not registered on the lists kept by the regional companies commits an offence punishable by up to one year’s imprisonment and a fine of €15,000.
The Companies of Auditors have to organise periodic checks to verify the quality of the audits done by their members and compliance with ethical obligations
The Decree of 12 August 1969 for the first time laid down an obligation for the CRRCs to carry out a periodic inspection of auditors’ activities to check the quality of the audits they have carried out.
In 1985, the CNCC concluded an agreement with the Commission des Opérations de Bourse (Stock Exchange Commission, COB) with a view to uniting to conduct quality control of companies calling for funds from the public.
Since 2003, the inspections of auditors have been carried out by the CNCC under the supervision of the High Council of Auditorship (Haut conseil du commissariat aux comptes, H3C – see below).
Disciplinary procedure
Any infringement of the laws, regulations and professional rules, any serious omission, any act contrary to integrity or honour, committed by an auditor constitutes misconduct subject to the disciplinary procedure. It must be stressed that disciplinary proceedings may be instituted even when the auditor in question is not criminally or civilly liable.
The auditors concerned must then appear before the disciplinary chamber of their regional CRCC. The regional disciplinary chambers are made up of judges and prominent members of the teaching and business communities, appointed by the Premier président (Chief Justice) of the relevant Court of Appeal. Only one auditor sits in the regional chambers, which comprise six members.
The regional disciplinary chambers can hand down various types of sanction according to the gravity of the misconduct: warning, reprimand, temporary prohibition on practising for a maximum of five years, removal from the list (which amounts to a permanent prohibition on practising). Appeals against decisions handed down by the disciplinary chambers may be referred to the H3C.
The financial crisis confronted by Vivendi Universal in 2002 highlighted the difficulty for auditors in preserving their independence vis-à-vis the large groups that pay them substantial fees
In 2002, the events that led to Mr Jean-Marie Messier’s departure from his position as chief executive at Vivendi Universal (VU) and his replacement by Mr Jean-René Fourtou had collateral effects on the auditors.
Indeed, the two firms of auditors working for VU (Salustro-Reydel and Andersen (Barbier Frinault & Cie), taken over in 2002 by Ernst & Young) were accused of having lacked independence towards this group, which paid them extremely high fees. This had led them to accept without protest VU’s use of doubtful accounting methods (frequent changes of the consolidation structure and the accounting methods with regard to provisions, presentation of extraordinary results as recurrent results, exclusive reference to EBITDA although this indicator did not correspond to any accounting principle in French law, omission of off-balance sheet commitments etc).
Le Monde, one of the main French daily newspapers, published a series of articles in the summer of 2002 seriously implicating Salustro-Reydel, which it claimed had given in to pressures exerted by Mr Messier and had even tried to dismiss some of its employees who made the mistake of criticising the accounting methods used by VU.
Subsequently, a report drawn up by the COB in 2003 regarding the sincerity of the information distributed by VU to investors also implicated the action of VU’s two auditing firms. Considering that the financial information supplied by VU had not been “accurate, precise and sincere”, the report underlined that: “the auditors did not conduct, nor it would seem undertake, any real action to avoid this situation … They consistently validated the aggressive accounting choices [of VU’s management] not hesitating in their written work to support their statements by legal appearances … whose limits they were well placed to know, to justify positions favourable to the group’s strategy.”
The COB concluded that: “the quality of their work and the reality of their independence vis-à-vis the managers … might be examined in the light of CNCC professional standards.”
The organisation of the profession was changed substantially in 2003 by the Financial Security Law (LSF)
The Vivendi Universal affair, on top of the highly publicised affairs coming to light abroad (especially in the US), engendered a certain feeling of defiance towards auditors. Accordingly, in August 2003 the French legislature adopted the financial security law (LSF) many of whose provisions are similar to those in the Sarbanes-Oxley Act of 2002, adopted by the US Congress following the Enron scandal.
The LSF provides much stricter regulation to the profession of auditor. But the majority of auditors welcomed these new rules as strengthening their role within the companies whose accounts they audit.
The Haut conseil du commissariat aux comptes (H3C)
The LSF also instituted a new body, separate from the CNCC: the Haut conseil du commissariat aux comptes (High Council of Auditorship, H3C), under the aegis of the Minister of Justice (Article L 821–3 of the Commercial Code).
The H3C consists of 12 members: three judges (one of which is the chairman), a representative of the Minister of the Economy and Finance, a university professor, three qualified people and the Chairman of the Financial Markets Authority (AMF) who is an ex-officio member.
A government commissioner attends meetings but has no right to vote. The H3C may set up specialist consultative committees and in this context may have recourse to experts. Decree no 2003–1121 of 25 November 2003 defined the organisation and operation of the H3C, whose current members were appointed by a Decree dated 29 November 2003.
The H3C’s mission is “to provide for supervision of the profession with the assistance of the Compagnie nationale des commissaires aux comptes”. In addition, it “ensures that auditors comply with ethical standards and remain independent”.
Thus the H3C is responsible for:
The H3C directs and supervises periodic inspections. Lastly, it is the forum of appeal for decisions taken by the commissions concerning registration on the lists of auditors and decisions taken by the regional disciplinary chambers.
In this way the LSF has instituted a dual regulation of auditors, shared between the H3C, on the one hand, and the CNCC and the CRCC, on the other.
The professional groupings are reflecting on the means of making the controls on the activity of auditors more effective
The measures taken in the context of the LSF have not put an end to the criticisms regarding the inadequacy of the controls aimed at encouraging auditors’ independence.
Thus, at the end of 2004, the listed company Marionnaud, a specialist in the sale of perfume and beauty products and owner of 1,200 shops (including more than 500 in France), was obliged by one of its auditors, appointed in June 2004, to correct its accounts for 2002 and 2003 by €93 million. Indeed, until then the company had committed various accounting irregularities, particularly by omitting to set aside provisions to cover the amount of gift tokens and other loyalty prizes distributed to its customers. Following the crisis triggered by this announcement, the family that owned the company was forced to withdraw from the capital and the company passed into the control of the AS Watson group managed by Li Ka-Sing.
However, it appeared that a quality control had been carried out in 2003 by the CNCC and the COB regarding the certification of the 2001 accounts, which Marionnaud’s former auditors had signed (before the appointment of the auditor which obliged the company to correct its accounts). This quality control had already brought to light this company’s accounting weaknesses regarding entries concerning the gift tokens. Despite this, no action had been instigated until Marionnaud’s auditor was changed (in June 2004), and the new auditor compelled the company to revise its accounting methods.
Numerous commentators criticised the inadequacy of the quality controls on auditors carried out under the direction of the CNCC and the inertia of this structure when the controls reveal anomalies that the auditor should have picked up.
Following this case, the H3C took various initiatives with a view to improving the efficiency of the CNCC’s quality controls. The H3C has proposed that a structure should be set up under its auspices with the task of individualised monitoring of quality controls. One specific task of this structure would be to refer cases to the AMF and/or the CNCC for them to give appropriate responses to deficiencies noted in the course of the quality control.
The characteristics of the auditors’ task are basically determined by Parliament and by regulations adopted or approved by the government. The conditions of their appointment and practice, their rights and obligations are principally set forth in the Commercial Code (Articles L 225–218 to L 225–242 and Articles L 820–1 to L 822–16).
Accordingly, the professional obligations fixed by these laws and regulations are mandatory and cannot be waived either by decisions taken by the CNCC and the H3C or by any agreement between an auditor and the companies whose accounts he certifies.
In the case of the tasks to be completed in the context of their statutory assignments, the auditors must comply with the professional audit standards prepared by the National Council (the deliberative organ of the CNCC), which are then submitted the H3C for its opinion (see above) and finally approved by the Minister of Justice.
As regards more particularly the rules of conflicts of interest, on 9 September 1998, the National Council of Auditors adopted a Code of Professional Ethical Standards, which set out the fundamental principles of conduct that must be followed (integrity, objectivity, competence, independence, professional secrecy). This Code will be replaced before the end of 2005.
To supplement this Code, in 1999 the CNCC and the COB set up a committee devoted to the ethics of independence, with the task of “contributing through its opinions and proposals to guaranteeing the independence of auditors of companies calling for funds from the public and the objectivity of their conclusions, in particular by facilitating the CNCC and the COB in the exercise of the tasks they have been allotted in this field”. This body was able to carry out case studies and issue individual opinions. It was abolished following the LSF of 2003, which set up the H3C and replaced the COB by the Financial Markets Authority (AMF).
The LSF has provided that the auditors’ Professional Code of Ethical Standards would henceforth be fixed by Prime Ministerial Decree, passed after consulting the H3C and the AMF. The CNCC has accordingly prepared a preliminary draft Decree, which has been submitted to these two bodies for their opinion. The opinion delivered by the H3C is available on the Internet (http://www.h3c.org). The Decree has not as yet been published.
Independence
Under French law, the auditor carries out his task mainly in the interest of the public rather than in the interest of the company that is paying his fees. That is why the law provides that auditors must be independent of the company whose accounts they audit.
Thus, under Article L 822–11 (I) of the Commercial Code, the auditor may not take, receive or keep, either directly or indirectly, any interest (i) in the entity whose accounts he is responsible for certifying or (ii) in an entity which controls or is controlled by that entity.
Accordingly, auditors may not carry out bookkeeping services or provide the legal secretariat or carry out consultancy for companies whose accounts they audit.
In addition Article L 822–10 of the Commercial Code provides that:
“the auditor’s duties are incompatible:
Incompatibilities
In order to avoid any doubt as regards their independence, auditors are subject to rules regarding incompatibility, whose aim is to avoid their being placed in situations of conflict of interest.
The LSF has added to the incompatibilities applicable to auditors. In particular, the LSF specifically addressed the problems of conflicts of interest that may arise when a firm of auditors belongs to a network made up of separate legal entities offering services of any kind (strategic advice, legal advice etc) to the company whose accounts the auditor certifies.
Now Article L 822–11 of the Commercial Code clearly prohibits an auditor “from providing the entity whose accounts he is responsible for certifying, or entities that control or are controlled by the said entity … with any advice or any other service that does not fall within the scope of the tasks directly linked to the auditor’s assignment …”
In addition, this prohibition is extended to all entities in the network (national or international) of which the firm of auditors is a member. As a result a firm of auditors belonging to a network cannot certify the accounts of a company if the company receives services from a member of that network (unless the services provided are directly linked to the task of certifying the accounts).
Contrary to the recommendations of certain members of Parliament, an auditor still may certify the accounts of a company even if that company controls – or is controlled by – another company that benefits from consultancy services provided by the network that the auditor belongs to.
The law merely requires that if the auditor is a member of a national or international network, he should give written notice that he is a member of the said network to the company that wishes to appoint him as auditor. Where applicable, he must inform the company of the overall amount of fees received by the network in respect of services carried out for parent companies or subsidiaries of the company whose accounts he proposes to audit, when these services are not directly linked to the auditor’s task.
Pursuant to Article L 225–108 of the Commercial Code, this information must be included in the documents made available to the shareholders of limited companies (société anonymes). The information is updated each year by the auditor and made available to the shareholders at the registered office of the company whose accounts he certifies.
Lastly, information regarding the amount of fees paid to each of the auditors is made available, at the registered office of the controlled legal entity, to partners or shareholders (Article L 820–3 of the Commercial Code).
It should be noted that the LSF only states the general principles with regard to incompatibilities, whereas the Sarbanes-Oxley Act defines precisely the range of activities incompatible with the certification of accounts (Section 201).
Indeed, it will be the CNCC that will issue, in co-operation with the H3C, a set of professional standards defining the scope of the LSF. This set of standards, referred to as the “norme périmetre” (outline standard), is currently at the drafting stage. A draft consisting of a list of the tasks “directly linked to the assignment” has been forwarded to the H3C. But it is possible that another approach may be chosen, involving laying down as many standards as there are assignments rather than seeking to lay down a general standard.
Non-interference in the management of the audited company
The independence of the auditor is necessary for certifying that a company’s accounts are in order and that they give a true and fair view of the company’s activity and financial results. On the other hand, it must not lead the auditor to take sides regarding the quality of the company’s management by its executives. Thus Article L 225–235 prohibits auditors from “any interference in management”. Indeed, if the auditor diversifies into supporting (or opposing) the strategic decisions taken by the management, he will lose the independence of spirit necessary for fulfilling his task.
For example, the auditor may not indicate that he considers that decisions taken by the managers are inappropriate (Cour d’appel de Paris, 24 June 1992, JCP (E) 1993, comments Viandier and Caussain) or certify that dismissal of the CEO has been carried out properly by the board (Cour d’appel de Paris, 10 November 1977, Juris-Data no 609).
Although auditors may not make a public statement regarding the quality of the management, on the other hand, they do have an obligation to draw the managers’ attention to any matter liable to jeopardise the continuity of the business that they observed in the course of their task (Articles L 234–1 and L 234–2 of the Commercial Code). In addition, if the managers fail to react appropriately, they must draw this to the attention of the board of directors then, where necessary, to the shareholders’ general meeting and finally, if none of the bodies has taken the appropriate measures, to the President of the Commercial Court.
It must be stressed that, in his report in respect of the “obligation to warn”, the auditor must merely indicate the elements which in his opinion are liable to jeopardise the continuity of the business and, where applicable, the reasons why the measures taken by the management up to that point are insufficient for resolving the problems. On the other hand, he may not indicate the measures which, in his view, should be taken, because then he would be interfering in the management of the company.
In practice, it is not always easy for an auditor to draw a line between his obligation to warn the management and the prohibition to interfere in the management.
It will be even more difficult in the future because the LSF now obliges auditors to “justify their assessments” in the context of their auditing task (Article L 225–235 of the Commercial Code).
After obtaining the views of the H3C, the CNCC has adopted a recommendation for defining the methods of applying this obligation. It has decided that the developments concerning the justification of the auditors’ assessments must be set out in a new, separate, second part, placed after the section in which the auditor’s opinion is expressed.
The CNCC further indicates that the auditors’ explanations must relate to elements that are fundamental for understanding the accounts, in particular inasmuch as events or significant decisions have been taken by the audited company and are translated in the accounts.
The CNCC specifies that: “The explanation of certain assessments cannot … be substituted for the need to express an opinion subject to reservations or a refusal to certify. The justification of the assessments must not be a disguised reservation.” Moreover, the wording chosen must “avoid all or any interpretations that would be liable to be detrimental to the legal entity at the time of the unreserved certification of its accounts”.
Hence, this is a delicate exercise for auditors. It is likely that they will have to devote a great deal of time and be extremely cautious in drafting these justifications.
The LSF has complicated matters further by providing that (i) each year the chairman of the board of directors (or the chairman of the supervisory board in the case of limited companies with a management board and supervisory board) must draw up a report concerning the internal audit procedures implemented within the company and that (ii) the auditors must present their comments on this report in a special report of their own annexed to their report on the accounts. The law specifies that the auditors’ comments relate to the internal audit procedures concerning the preparation and processing of accounting and financial information.
This is a genuinely new task, which has led certain audit firms to review their internal organisation so as to set in place structures dedicated to risk management.
A technical opinion drawn up by the CNCC, that takes the H3C’s comments into account, has defined the scope of this “report on the report”. This opinion encourages auditors to confine themselves to examining the sincerity of the information and declarations made by the management regarding the internal audit procedures, without evaluating the internal audit procedures as such.
This position on the part of the CNCC has been criticised by commentators who take the view that auditors should not restrict themselves to a purely formal verification of the declarations made in the report about the internal audits. According to these commentators, it is clear that the legislature’s intention is to culminate in a dual evaluation of the company’s internal audit procedures: one by the business’s chief executive and the other by the auditors. However, the CNCC’s position seems justified in the light of the prohibition on interference in management defined by the Commercial Code.
It must be noted that, in view of the guarantee against interference in management, Articles L 822–12 and L 822–13 of the Commercial Code prohibit a company’s auditors from becoming either a manager or an employee of that company for five years after they have ceased certifying the accounts. The same prohibition applies in the case of entities that control or are controlled by the company in question.
Correspondingly, a manager or employee of a company may not be appointed as an auditor of that company for a period of five years from the date he left the company. During the same period, he may not become auditor of any company that holds at least 10% of the capital of his former company or of any company at least 10% of whose capital is held by his former company.
Obligation to reveal offences
French auditors have an obligation to reveal to the judicial authorities offences that come to their attention in the course of carrying out their task (Article L 225–240 of the Commercial Code). According to the CNCC, such matters must only be revealed if the facts (i) are “significant and deliberate”, and (ii) fall within the field of company law, and (iii) are liable to have an impact on the accounts (Professional Practice Standard 6–701).
If an auditor refrains from revealing facts that constitute offences although he should have done so, he will be criminally liable (to a maximum of five years’ imprisonment and/or a maximum fine of €75,000, under Article L 820–7 of the Commercial Code).
A recent case illustrated the obligations imposed on auditors. It concerns the packaging group Otor, where there was a dispute about control between the investment fund Carlyle and the founder shareholders. One of Otor’s two auditors, who had detected irregularities in the accounts, denounced these shareholders to the Public Prosecutor.
When at the beginning of 2004, investigatory proceedings were commenced against the founder shareholders for abuse of corporate assets and false invoices, the founder shareholders decided to sanction the auditor who had denounced the irregularities (and whose six-year term of office ended that year) by getting the shareholders’ general meeting in June 2004 to vote in favour of a resolution providing for his replacement by another firm of auditors. Thus, the auditor who did his duty by denouncing facts that he considered illegal lost his office.
As regards Otor’s other auditor, who had not pointed out the offences, although he did not lose his term of office, he was included in the investigation into Otor’s management team. Indeed, it appeared that this firm may have been in breach of the ethical standards of the profession by agreeing, in 2002 and 2003, to keep the accounts that it was responsible for certifying. Such a conflict of interest is strictly prohibited by Article L 822–11 of the Commercial Code (see above).
Duration of the term of office and renewal of the term of office, factors of independence
According to the Commercial Code, auditors are appointed for six years and during the term of office they may only be dismissed by a court decision. This confers a certain power on them vis-à-vis the entities that they audit, guaranteeing the continuity of their office in case of disagreement.
In sociétés anonymes, auditors are proposed for appointment by the general meeting by a draft resolution drawn up by the board of directors or supervisory board (Article L 225–228 of the Commercial Code).
If a company is calling for funds from public investors, the board of directors selects its prospective the auditor by a vote in which the general manager and deputy general manager – if they are member of the Board – abstain. The AMF (Financial Markets Authority) is informed of proposals to appoint or renew auditors and has the right to make any comment it deems necessary regarding such proposals.
Lastly, in the case of companies calling for funds from public investors, the LSF has imposed a system of periodic rotation of the individuals acting as auditors. It is now prohibited for one and the same individual to certify the accounts of a company calling for funds from public investors for more than six financial years. These provisions will become applicable with effect from 1 August 2006 (Article L 822–14 of the Commercial Code).
The practical implementation of the numerous changes introduced by the LSF is far from complete.
The Decree approving the Professional Code of Practice is due to be published before the end of 2005. This text and the various measures that will be taken by the H3C and the CNCC will determine the fixing of the practical rules relating to the prevention of conflicts of interest.
Moreover, it must be noted that, within the CNCC, firms of auditors that audit companies calling for funds from public investors (in practice the audit of quoted companies is done by less than a dozen firms) are grouped within the APE (Appel Public à l’Epargne) Department.
This department will probably acquire greater autonomy and play an increasing role due to the fact that the issue of conflicts of interest is fundamental when it relates to the auditing of the accounts of quoted companies.
Ministère de la Justice – Direction des affaires civiles et du sceau – Sous-direction du droit commercial 13, place Vendôme 75042 Paris CEDEX 01 Tel: +33144776060
Haut Conseil du Commissariat aux Comptes (H3C) 13, place Vendôme 75042 Paris CEDEX 01 Website: http://www.h3c.org
Compagnie Nationale des Commissaires aux Comptes (CNCC) 8, rue de l’Amiral-de-Coligny 75001 Paris Tel: +33144778282 Fax: +33 1 44 77 82 28 Website: http://www.cncc.fr
Compagnie Régionale des Commissaires aux Comptes de Paris 29, boulevard de Courcelles 75008 Paris Tel: +33153839433 Fax: +33 1 42 25 06 61 E-mail: contact@crcc-paris.fr Website: http://www.crcc-paris.fr
Autorité des marchés financiers (AMF) 17, place de la Bourse 75082 Paris CEDEX 02 Tel: +33153456000 Fax: +33 1 53 45 61 00 E-mail: contact@amf-france.org Website: http://www.amf-france.org
The term ‘lawyer’ in this section refers to the French legal profession of ‘Avocat’. The profession of Avocat in France has evolved considerably since the merger in 1992 of the two legal professions which existed before that date, namely the traditional profession of Avocats (comprising about 18,000 members at that time), and the profession of Conseils Juridiques (about 5,000 members), an unregulated profession (before 1971), which met a need for legal services (particularly in tax, corporate and commercial law) insufficiently supplied by most Avocats.
Before the merger, most Avocats were predominantly involved with litigation work, whereas Conseils Juridiques worked exclusively on advisory and transactional work, mainly for corporate clients. All the large Anglo-Saxon law firms established in France before 1992 were registered as Conseils Juridiques and none of them did litigation work.
Although the profession of Conseil Juridique was also regulated and subject to a code of conduct, including a general provision on conflicts of interest, in practice, conflicts of interest were generally dealt with in a flexible manner by members of the profession, often using pragmatic Anglo-Saxon solutions such as Chinese walls. Avocats were more exposed to conflicts of interest due to the litigious nature of their work and Bar Councils have always exercised strict control over this issue.
Lawyers in France are now gathered together in a single, larger profession (more than 42,000 members today) governed by the same rules (Avocat Act of 31 December 1971; Decree no 91–1197 of 27 November 1991; Decree no 2005–790 of 12 July 2005), and regulated by the same professional bodies: the Bar Councils (les Conseils de l’ordre) and the National Bar Council (le Conseil National des Barreaux), which adopted a single Code of Conduct in 2004 (Règlement Intérieur Unifié des Barreaux de France, RIU). The RIU defines lawyers’ duties, in particular those related to client confidentiality and conflicts of interest.
The Bar Councils administer the rules on conflicts of interest of an ethical nature (which are of a different nature from commercial conflicts of interest). If a difficulty arises in a matter, the Bar Councils will give simple advice (whether or not there is a conflict of an ethical nature) and may make a recommendation to the lawyer. If this recommendation is not followed, the lawyer can be subject to disciplinary sanction. The Supreme Court ruled (Cass 1ère civ, 27 March 2001) that if the recommendation was not followed by the lawyer and no subsequent sanction was taken by the Bar Council, a court could give an injunction to a party to change lawyer. But this ruling is the subject of debate.
Since disciplinary decisions taken by the Bar Councils can be appealed, the Courts of Appeal and the Supreme Court have an important role in defining conflicts of interest. But when the French Courts of Appeal and the Supreme Court rule on a conflict of interest matter involving lawyers, it is always from a disciplinary angle. On the other hand, when they are deciding upon a civil, commercial or criminal matter, French courts are not interested in the lawyers’ conflicts of interest, which must be dealt with primarily by the Bar Councils.
Conflicts of interest in the legal sector are closely related to the lawyer’s duty of confidentiality (Secret professionnel). The professional secrecy owed by a lawyer to his client is a matter of public policy in France. It is very strict and any breach of this duty can lead to criminal sanctions. Clients cannot waive this duty. A lawyer is therefore not allowed to provide direct information to any third parties (financial institutions, insurers or auditors, for example), even with the client’s consent. In practice, this restriction (which does not exist in most other jurisdictions) is not always strictly applied, in particular when it is not compatible with well-established market practices, such as reliance letters.
Before 1992, the Conseils Juridiques did not undertake litigation work and were therefore less exposed to ‘hard’ conflict of interests. The Avocats who, before 1992, mainly did litigation work were technically more exposed to a risk of conflicts of interest. However, the size of Avocats’ law firms before 1992 was very small (very few Parisian law firms exceeded 30 lawyers) and the risk of conflicts of interest was consequently rather low and generally easy to identify.
Since 1992, the legal market in France has developed considerably as a result of deregulation and the globalisation of the economy. There has been a concentration of law firms and a considerable increase in size of French law firms. The concentration and increase in size of French law firms consequently increased the risk of conflicts within these firms, which then had to organise themselves to cope with this new problem. Under the influence of the lawyers who formerly practised as Conseil Juridique, the conflict of interest rules have been relaxed in the last decade in order to take account of (i) the changing nature of the work handled by the new profession of Avocat (which is now more of a transactional nature and less contentious in proportion) and (ii) the increasing number of clients within each law firm. An illustration of this is the official recognition in the RIU of “Chinese walls” in non-contentious matters. Not only have the rules on conflicts become more flexible, but their content is more detailed.
Another consequence of the merger is that the tax and legal advisers who were affiliated to the large auditors and consulting networks (KPMG, Arthur Andersen, Ernst & Young, PwC, Deloitte) became Avocats in 1992 along with all other former Conseils Juridiques. The independence of these law firms which were part of the auditors and consulting networks was discussed by those who considered that these law firms could no longer offer the independence expected from a lawyer.
The Enron case increased the need for further control of potential conflicts of interest, in particular in these networks and in view of the fact the remaining lawyers from Arthur Andersen have now rejoined E&Y Law, whereas the other law firms affiliated to the other audit firms have changed their names and taken steps to increase their independence.
The most detailed source of law concerning conflicts of interest is Article 4 of the RIU which provides a definition of “conflicts of interest”, and sets out the conditions in which a lawyer may or may not act for a client. The provisions of Article 4 of the RIU derive from a decision taken by the National Bar Council on 24 April 2004.
The principle set out in Article 4.1 of the RIU is: “A lawyer cannot be the adviser, defender or representative of more than one party in the same matter if there is a conflict between their interests or, unless the parties are in agreement, there is a serious risk of such a conflict.” Articles 4.2 and 4.3 of the RIU set out more detailed definitions and requirements.
Article 55 of the Law of 31 December 1971 also provides that a lawyer should be prevented from acting if he “has a direct or indirect interest in the service provided”.
Article 155 of the Decree of 27 November 1991 (which was repealed in July 2005) contained the following provisions:
“A lawyer must be neither the adviser nor representative or defender of more than one client in the same matter if there is a conflict between the interests of his/her client or, unless the parties are in agreement, if there is a serious risk of such a conflict.
He shall, unless the parties are in agreement, refrain from acting for or advising [s’occuper des affaires] all the clients concerned whenever (i) a conflict of interest arises (ii) the client confidentiality [ie secret professionnel] risks being breached or (iii) his/her independence may no longer be total.
He/she cannot receive instructions from a new client if the information given by a former client risks being compromised or where his/her knowledge of the former client’s business [sa connaissance des affaires de ce dernier] would unjustifiably favour the new client.
When lawyers practice as a group, the provisions in the above paragraphs shall apply to the group as a whole and to its members.”
Article 155 of the Decree of 27 November 1991, mentioned above, has been repealed by the Decree of 12 July 2005, but replaced by Article 7 of this new Decree which repeats exactly the same wording as that contained in the former Article 155. The following provision has however been added:
“They [the provisions relating to conflicts of interest] shall also apply to lawyers practising their profession within a resource-sharing structure if, within this structure, there is the risk that professional secrecy will be breached.”
This additional sentence repeats the wording already existing in the RIU concerning conflicts within resource-sharing structures.
The Code of Ethics applicable to EU lawyers which was adopted on 28 October 1988 (and subsequently modified on 28 November 1998 and 6 December 2002) sets out the rules on conflicts of interest applicable to lawyers within the EU (Section 3.2). These rules are the same as those provided for in Article 7 of the Decree of 12 July 2005 except that they do not provide for a lawyer to continue acting for a client with the parties’ written agreement when (i) a conflict arises, (ii) client confidentiality risks being breached or
(iii) the lawyer’s independence may no longer be total.
Section 4.2 of the RIU provides a precise definition of a conflict of interest in contentious and non-contentious matters. It also describes the circumstances in which there is no conflict of interest.
France
Definition of a conflict of interest
This definition is set out in Article 4.2 of the RIU: “There is a conflict of interest:
There is a serious risk of a conflict of interest when a foreseeable change of circumstances in the situation initially put before the lawyer gives him reason to fear that one of the problems referred to above will arise.”
Situation where there is no conflict of interest
Section 4.2 of the RIU also provides: “There is no conflict of interest:
The latter provision notably improves the position of French lawyers since it allows Chinese walls provided that the clients are duly informed of the situation and have accepted it.
Limits of lawyers’ involvement
Section 4.3 of the RIU provides specific prohibitions and requirements:
“+ The lawyer shall, unless the parties agree otherwise, abstain from acting for or advising [s’occuper des affaires] all the clients concerned whenever (i) a conflict of interest arises, (ii) client confidentiality [ie secret professionnel] risks being breached or (iii) his or her independence may no longer be total.”
This provision differentiates between the French rules and those of the EU Code of Ethics since it expressly allows a lawyer to continue acting for a client when a conflict arises or when client confidentiality might be breached, provided that the parties agree to it. This provision addresses situations in which the lawyer would otherwise have to stop working for any of the parties involved in the matter. There is no such provision in the EU Code of Ethics.
“+ He/she cannot receive instructions from a new client if the
information given by a former client risks being compromised; or
where his/her knowledge of the former client’s business [sa
connaissance des affaires de ce dernier] would unjustifiably favour the new
client.
The latter provision highlights a potential source of conflicts of interest, since most of the assistant lawyers of French law firms are self-employed and are therefore allowed to work for their own clients, whose interests may be in conflict with those of the partners of the firm for whom they work and with whom they form a group.
The requirements set out by the RIU comply with the general principles of the profession of Avocat, in particular these of loyalty, independence and delicacy/tactfulness (délicatesse).
They are more liberal than they used to be a few years ago. Restrictions can often be avoided, especially in non-contentious matters, provided that the client’s consent is obtained.
The rules on conflicts of interest in France are now well established and are unlikely to be modified substantially in the next few years. This is evidenced by the wording used in the new Article 7 of the Decree of 12 July 2005 (which defines the requirements for lawyers in terms of conflicts of interest) which is identical to the wording used in Article 155 of the Decree of 1991, with the exception of one additional sentence of minor interest.
If the largest law firms (whether those of French origin or the French offices of global law firms) have generally coped with the difficulties resulting from their size by implementing various methods or systems of conflict clearance, the middle-ranking law firms are not always well equipped to identify potential conflicts of interest in advance. Such firms may face difficulties as they grow.
Some large companies have adopted the strategy of sharing out their legal work amongst all the reputable law firms in the market to increase the chances these firms will be “conflicted out” should an opponent in a litigious matter seek to retain them.
A recent development is that new economy business start-ups have offered shares to lawyers in payment of their fees. This practical solution has been approved by the Bar Council Ethical Committee. However, it may be that such practices will create conflicts.
French Ministry of Justice website: http://www.justice.gouv.fr
French law online database website: http://www.legifrance.gouv.fr
National Bar Council (Conseil National des Barreaux) website:
http://www.cnb.avocat.fr
Paris Bar Council (Ordre des Avocats au Barreau de Paris) website:
http://www.avocatparis.org
