1. General introduction – summary
In the Netherlands, traditionally not a litigious country, there have been several mass litigations brought by small retail investors who have joined forces in an attempt to claim damages from financial institutions in relation to securities issues. Important recent cases related to issues by Coop AG (late 1980s), World Online (March 2001) and Dexia (2000–05).
Over the last four years, US financial analysts have been severely criticised for perceived conflicts of interest. Similar criticisms were made in the Netherlands following the Ahold affair, which was of special significance since Ahold was regarded as a blue chip firm and had many small retail investors. At a time when some investors were selling out of Ahold, most analysts remained positive about the company’s prospects – right up to the point when the company admitted its earnings had been wildly overstated and the shares collapsed. There were, however, no indications that the analysts knew better. They defended themselves by stating they could believe the board and the accountants and that Chinese walls within the financial institutions were well in place. It appears to have been a case when not only the public side of the financial industry (eg research, sales, trading) but also the private side (eg lending, investment banking) was taken by surprise.
Investment advisers and private bankers often lose damages claims brought by disgruntled small investors. A concept comparable with due care or fiduciary duty has been developed in relation to banks’ dealings with retail investors, through regulations, in court cases based on interpretation of the contract (general banking terms and conditions of business that are used by all banks) between the bank and the retail client, and in cases of special arbitration for complaints by retail clients against banks.
On the other hand, in the wholesale market the few large Dutch banks manage to work for many connected large commercial clients at the same time. The four largest banks, ABN AMRO, ING, Rabobank and Fortis, account for 70 per cent of domestic lending capacity, and they have also expanded internationally. This creates a dynamic of its own. So the distinction between retail and wholesale clients is not only of interest from a regulatory perspective but also because of the way the market is structured.
1 PricewaterhouseCoopers Accountants.
2 Rabobank.
Sources of law and practice
Dutch law and practice in the area of conflicts of interest in the financial industry has regulatory, civil and criminal aspects.
The Act on the Supervision of the Securities Trade of 1995 (the Act) lays down the legal basis for the present regulatory system. The Act was worked out in the Decree on the Supervision of the Securities Trade 1995 (the Decree) and in turn implemented by Further Regulations on Market Conduct Supervision of Securities Trade 1999 and later 2002 (the Regulations). The Regulations create a system of avoiding conflicts of interest by creating Chinese walls and giving the required information about the Chinese walls to clients and the regulator. It also requires the banks to have internal integrity rules and high level compliance officers.
Furthermore, the Decree on the Reputable Management of 2003 instructs securities institutions to have an adequate policy on conflicts. The Association of Analysts have also issued a Code of Good Conduct.
The regulator for surveillance, interpretation and enforcement
While the Dutch Central Bank was originally the supervisor for all aspects of financial institutions, it now primarily supervises the prudential aspects. Since 1999, the Netherlands has moved from self-regulation to statutory supervision for conduct of business rules and regulations have become broader. The Authority for the Financial Markets (AFM) supervises this conduct of business.
The AFM may inspect books and records of financial institutions; make general policy directives; issue public reprimands and levy fines; and dismiss directors and officers. Furthermore, it can appoint a silent caretaker to a bank.
Auditors must, according to section 30 of the Act on Supervision of Credit Institutions and section 11 a of the Act on the Supervision of the Securities Trade Act 1995 report to the supervisors as soon as possible any circumstance of which he becomes aware in carrying out his duties and that:
| a. | is in conflict with the requirements laid down with regard to the |
|
| granting of licences; |
| b. | is in conflict with the obligations imposed by or pursuant to this Act; |
| c. | jeopardises the continued existence of the securities institution; or |
| d. | causes him to refuse to give his statement. |
This requirement to report also includes all of the above-mentioned regulations, such as systems of Chinese walls, internal regulations and high level compliance officers.
Definitions and culture of “conflict of interest”
Section 19 of the Regulations (in summary) sets out two specific areas of possible conflict: collisions between institution and client interests; and collisions between the interests of separate clients. More generally, it states that the proper operation of the securities markets and the confidence of investors of such markets may not be damaged. If there may be a danger of a conflict or other damage, the institution shall take all necessary measures to ensure that it is able to operate independently, ie the creation of Chinese walls to prevent unauthorised dissemination of insider information or other market-confidential information. The purpose is first to avoid the spread of insider information, but also to ensure the interests of the client come before the bank’s own interests when other information is used.
Under Section 25 of the Regulations, a securities institution must act in the interest of its clients and give priority to the interest of the client. This relates only to securities brokerage.
Pursuant to Section 33 of the Regulations, a securities institution must provide its clients with information about existing or potential conflicts of interest and also about the Chinese walls. This is only applicable for retail clients.
This leaves a whole area of conflict management in the wholesale sector open for discretion and interpretation. Senior compliance officers of financial institutions regularly have internal discussions with different divisions of the financial institutions about the regulations, civil law and general standards of integrity when managing these conflicts. The following distinctions can be made:
1. What relationship does the bank has with its client? Is it only a normal contractual relationship (eg a lending relationship) or does it have a special relationship with the client because it gives advice to him (eg a corporate advisory relationship)? Even if Article 25 of the Regulations is not directly applicable, general principles of law (comparable with the English concept of fiduciary duty) put a bigger responsibility on the bank to manage its conflicts of interest properly. For example, the Dutch Civil Code (Book 7, sections 416 and 417) obliges the intermediary or agent to be extra clear in the contractual relationship with the client if there is a possible conflict of interest.
1. A distinction can be made between different types of conflict:
1. Different matter conflict: A bank gives loans to clients competing in the same sector. One could argue that both clients should be given loans on similar conditions. In our opinion, this is too strict, because the bank is acting according to normal contractual relationships, and its bargaining power is likely to be different in relation to each client.
2. Connected matter conflict: A bank offers financing to two bidders for the same target in an auction. The bank must ensure that each deal team remains ignorant of the price offered by the bidder it does not represent. Chinese walls should achieve this, so that the bank has only normal contractual relationships with the bidders.
3. Same matter conflict: A bank offers advisory services both to the seller and the buyer: this can create problems, as the clients are in opposition, and the bank has an interest in the seller achieving the higher price and the buyer the lowest price. It could be argued that in these cases the duty of undivided loyalty goes further than merely the duty of confidentiality, for which Chinese walls could provide a solution. In such cases the bank can only proceed if it has the very clear “informed consent” of both clients, which may change the role of the bank to a brokerage function. In some cases, a specific aspect of the advice or financial valuation should be referred to another party. These situations can be solved by clear agreements between the wholesale client and the bank.
In the bank-client discussions the client can ask for exclusivity or accept to trust the Chinese walls and by doing so trust that there is no conflict of interest between the clients or the bank and the client.
2. Background/environment
Traditionally the Dutch Central Bank regulated the financial institutions strictly by way of prudential supervision. From the 1950s until the 1980s, large concentrations of financial institutions were forbidden. Banks were not allowed to own controlling shareholdings in any other companies and the Dutch Central Bank sometimes quietly forced bank directors of banks to leave.
Increased investments in listed shares by retail clients in the 1970s and 1980s made the integrity of the financial sector more important. Prompted by the Central Bank, the Association of Banks issued a Code on Chinese walls in 1991. The Code was inspired by the insider trading (criminal) law of 1989.
During the 1980s, more retail investors were attracted to the securities markets, sharpening awareness of the need for more formal integrity rules. The boom in stock prices in the 1990s, and the subsequent burst of the equity bubble, accelerated reform. A stream of EU directives added to the pressure for change.
Mass court cases (eg Coop AG, World Online, Dexia) have made financial institutions much more careful. The four large Dutch banks have become international businesses and are greatly influenced by practices in other countries.
The corporate governance Code (Tabaksblat) obliges large investors such as pension funds and financial institutions to vote at shareholder meetings. This increases possible sources of conflicts of interest within such institutions. May they vote in their own interest, which could be predominantly as a lender, or must they vote solely as a shareholder? We believe they should follow the latter course.
3. Requirements
Organisational requirements
Article 7 of the Act requires securities institutions to obtain a licence and submit to supervision. Articles 24a and 35 of the Decree oblige securities institutions to act in the interest of their clients and the adequate functioning of securities markets, to try to avoid conflicts of interests and, when these are unavoidable, to deal with problems fairly.
The Regulations define types of securities institutions and oblige them to avoid conflicts of interest by creating organisational and functional separation of business domains, ie Chinese walls. Approved devices include the creation of separate legal entities, physical separation of different activities (preferably in separate rooms), and a separation of organisational structure and personnel to the most senior level possible. It will be impossible to avoid the board of managing directors looking over Chinese walls, because the board is responsible for all actions at lower levels. It is also possible that one managing director will be responsible for two business domains. The Regulations also:
+
make it mandatory to disclose to clients potential conflicts of interest between the securities institution and the client and the measures taken, ie Chinese walls;
+ discuss the possibility of introducing the client to another securities
institution;
+ in case of securities lease agreements, oblige the institution to disclose to the client how the agreement can be bought off; + oblige the securities institution to deal with complaints properly; and + oblige the securities institution to execute orders quickly and refrain from too high a transaction frequency and to obtain information concerning its client’s financial position (in the interest of the client).
Insider trading
Insider trading is a crime. Section 46 of the Act prohibits persons with inside information from carrying out transactions in securities that are listed or are likely to be listed in the near future on a stock exchange (or securities whose value is at least in part determined by those securities).
Inside information is knowledge of specific information about a company or institution to which the securities relate or the trade in said securities:
(a) has not been made public; and
(b) where disclosure could reasonably be expected to affect the price of the security (up or down). No intention to misuse information is required under present law.
There is an exemption for securities dealers. This enables employees of the securities department of a financial institution to carry out transactions (on behalf of the financial institution) in security X although the employees of, for example, the credit department of this financial institution (and hence the financial institution itself) possess inside information concerning the company that has issued security X. This exception only applies if adequate Chinese walls are in place.
“Tipping” is also prohibited, unless this is done as part of a person’s normal duties, profession or position.
Securities analysts
An AFM policy document has clarified the extent to which the prohibition against insider trading and tipping restricts the distribution of research reports.
The following points can be made:
+ if only public knowledge is used, it is not inside information;
+ the recommendation in the report itself can be inside information;
+ if the recommendation is not published, there is no inside information. The financial institution may use oral recommendations for itself and its clients – in case of anticipating future demand, because the financial institution knows of a large buyer, the institution must inform the client of a potential conflict;
+ if the recommendation is published, it is only if the financial institution can assume that the recommendation may have an influence on the price that there is inside information;
+ a recommendation which is to be published but is currently available only in a restricted circle may not be used by the financial institution or for its client before it is published;
+ adequate Chinese walls and independent researchers should avoid
problems in this area; and
+ the Code of the Association of Analysts describes obligations of integrity objectively. An analyst must not act against the interest of clients and should refrain from acting for a client if the analyst has an interest himself. The sanction is one year’s suspension from the Association.
4. Outlook
Dutch insider trading law will be amended as soon as the EU Market Abuse Directive is implemented. Changes are now scheduled to take effect from August/September 2005. Like many other Member States, the Netherlands failed to meet the implementation deadline of 12 October 2004.
The draft reforms include a special section on research reports by analysts, which may mean substantial differences to the regulations described above. Other key points include:
+ financial journalists will also be regulated;
+ facts are to be distinguished from interpretations;
+ credit rating agencies are not subject to the regulation; and
+ there will be a system of self-regulation for analysts under the Dutch Securities Institute composed of the Association of Analysts and the Association of Banks – this all falls under the supervision of AFM.
The implementation of the EU’s MIFID Directive will mean that rules on conflicts and Chinese walls affect not only retail but also wholesale clients, a substantial change. Moves toward stricter conflicts of interest compliance for financial institutions in the US and UK will continue to be an influence.
SECTION B: AUDITORS
1. General introduction
From time to time, the general public, the investor community, employees, customers, suppliers and other stakeholders are startled by problems arising at companies with impeccable reputations.
As early as in 1602, the first initial public offering of shares in the Netherlands gave rise to a call for better governance. The Verenigde Oost-Indische Compagnie, the flagship company of the Dutch Golden Century, did not live up to its promise to provide information about its performance and to pay dividends.
In 1879, the misrepresentation of the financial performance of Afrikaanse Handelsvereeniging was the immediate cause for the start of the audit profession in the Netherlands.
More recently, scandals such as those involving Enron, WorldCom, Parmalat and Ahold undermined the trust of these companies’ stakeholders and the general public.
The enormous impact of these incidents triggered an extensive discussion on the corporate governance model and the role of auditors in particular at entities of public interest. Public interest entities (PIEs) are defined as entities that enjoy the particular attention of the general public, because of their activity, size, number of personnel or social standing.
The treatment of conflicts of interest and, in particular, independence is of central importance to the audit function.
In addition to auditing historical financial information, audit firms provide a range of other assurance and related services to audit and non-audit clients. At the end of this section, due diligence services will be discussed as they are particularly interesting in view of the subject of this survey.
2. Audit of historical financial information
History/environment
From its inception back in 1879, the audit profession in the Netherlands was an unregulated private initiative. Several umbrella organisations emerged and were ultimately united in the NIVA (Nederlands Instituut van Accountants, the Dutch institute of accountants).
The foundation for the current profession was laid on 18 June 1962 in the Wet op de Registeraccountants (WRA). This law created a public organisation, the NIVRA (Koninklijk Nederlands Instituut van Registeraccountants, the Dutch institute of registered accountants). With NIVRA, a self-regulating structure for the audit profession was introduced.The NIVRA register currently includes some 13,000 members, of whom some 4,300 work on public audits.
The environment in which the auditor operates is determined by a hierarchy of regulations, such as (in order of importance): applicable laws; professional decrees; including the Code of Conduct; and professional guidelines.
Applicable law, regulation, codes
Book 2, Part 9 of the Netherlands Civil Code requires legal entities to file financial statements with the Trade Registry of the Chamber of Commerce no later than the end of the thirteenth month following year-end. Companies exceeding a certain size are subject to a statutory audit obligation.
In December 2003, the Tabaksblat Committee issued a new Code on Corporate Governance. The code replaced the 1997 Corporate Governance in the Netherlands Report; The Forty Recommendations of the Peters Committee.
The Code provides principles and best-practice standards and applies to all companies that have their registered offices in the Netherlands and whose shares or depositary receipts are officially listed on a government-recognised stock exchange (investment funds are exempted), but the effect of the Code appears to be much more far-reaching.
The Detailed Guidelines on Independence (Nadere Voorschriften inzake Onafhankelijkheid, January 2003, updated January 2005 in the Independence Guidelines) align the Dutch Code of Conduct with the 2002 EU Recommendation on Statutory Auditors’ Independence in the EU: A set of fundamental principles and with the Code of Ethics of the International Federation of Accountants (IFAC).
The Independence Guidelines apply to auditors conducting assurance engagements. The Independence Guidelines articulate the three key principles of independence, objectivity and integrity, which are the fundamental basis for public trust. The ultimate test is that the requirements are met if a well-informed expert overseeing all relevant facts and circumstances in relation to the audit engagement will conclude that the auditor was objective and independent when reaching conclusions in respect of all issues raised during the audit process.
On 15 June 2005, the International Standard on Quality Control 1 (ISQC1) became effective. ISQC1 sets standards for firms that perform audits and reviews of historical financial information and carry out other assurance and related engagements. On the same date, ISA 220, the quality control for audits of historical financial information, became effective.
On 28 June 2005, the Wet toezicht accountantsorganisaties (Wta), the law that regulates public oversight of the audit profession, was approved in the Lower House of the Dutch Parliament.
Conflicts of interest and independence
Under sections 107 and 217 Book 2 of the Netherlands Civil Code, statutory auditors are appointed by the annual general meeting of shareholders. If they are not, the supervisory board (if any) will be responsible for the appointment. In the last instance this responsibility rests with the executive board.
To address the threat to independence that stems from the auditor being appointed and paid for its services by the executive board, the Dutch Corporate Governance Code recommends referring the decision on the auditors’ appointment to the annual general meeting of shareholders, subject to nominations from the supervisory board. If the supervisory board comprises more than four members, a separate audit committee is formed.
The audit committee, or in its absence the supervisory board, monitors on an annual basis the relationship with the external auditor, the remuneration, the adherence to independence requirements, partner-rotation policies and the nature and extent of non-audit services provided by the network to which the auditor belongs. Every four years, the auditor’s performance is thoroughly evaluated; the conclusions are reported to the annual general meeting of shareholders and serve as a basis for reappointment.
The Independence Guidelines require the auditor to evaluate the client’s corporate governance policies and the client’s compliance therewith.
Wta, ISQC1 and the Independence Guidelines require audit firms to establish policies and procedures to provide them with reasonable assurance that a firm maintains its independence. Policies require systematic collection of relevant information and monitoring processes, which should be capable of being audited.
Any threats to independence identified should be evaluated and appropriate action should be taken to reduce them to acceptable levels. Ultimately this may lead to the withdrawal from the engagement or the rejection of a potential engagement.
On the level of individual engagements, provisions apply regarding fees (eg maximum fee compared with total fees of an audit firm), rotation (seven-year rotation schedule for PIE clients), personal, business or financial relations, and services that are prohibited or require additional independence safeguards (including accounting assistance, valuations, design and implementation of information systems, certain legal services, interim management, recruitment and certain corporate finance services).
In accordance with ISA 220, responsibility for adherence to these requirements at engagement level rests with the audit partner responsible for the engagement. ISA 220.40 introduces an engagement quality control partner for listed companies, who should monitor the quality, including the adherence to independence requirements, of audit engagements.
Public oversight
The Wta transfers the oversight of the audit profession from the NIVRA to the Netherlands Authority for the Financial Markets (AFM). The AFM will provide concessions to audit firms, which entitle the holder to perform statutory audits of annual financial statements. The AFM may attach specific conditions or impose restrictions to concessions provided. Furthermore, AFM may issue directives and is responsible for monitoring adherence to the provisions of the Wta.
Outlook
The landscape has changed dramatically in the past 18 months. The increasing influence of the supervisory board and ultimately the annual general meeting of shareholders, the strict independence rules applicable to auditors of historical financial information, in particular in relation to PIEs, and the independent auditor oversight by AFM should be sufficient to regain the trust and confidence of the general public which is crucial for the vitality of the financial markets.
3. Other assurance and related services
The Dutch Corporate Governance Code and the Independence Guidelines of NIVRA primarily focus on the role of the auditor. Audit firms provide a variety of other assurance and related services as well. Clients engage audit firms to perform these services, because of the specific skills, expertise and experience they require for such services and that is typically available within audit firms. Other assurance and related services are addressed in the regulations discussed above to the extent that they are provided to audit clients.
Certain related services to audit clients, such as accounting assistance and valuations, are prohibited or subject to restrictions. Other related services, such as due diligence services, are permitted. The requirements for audit firms in providing related services to audit and non-audit clients are laid down in specific guidelines and in the Code of Conduct (GBR 1994).
Although the same principles of objectivity, integrity and independence (in mind) apply, requirements are different in nature, which is justified by the fact that other services are specifically intended for a particular client, or a restricted user group, and will not be made available to the general public for the purposes of instilling confidence in the integrity of financial information.
An important category of related services provided by audit firms are services in relation to acquisitions or the sale of shares in companies, of business activities or combinations thereof (due diligence services). By definition, such transactions include two or more parties with conflicting interests. Furthermore, many sales processes are organised as controlled auctions, in which a relatively large group of potential buyers is invited to bid on the business for sale, increasing the number of parties involved.
When engaged by a potential client the initial step the due diligence specialists will take is to perform client acceptance research. Who is this client? Does the audit firm already have a business relationship with this client? What is the nature of this relationship, if any? What is the nature of the services requested by the client? Similar questions on the potential acquisition target are addressed. The research on the acquisition target may reveal whether there are potential other bidders. The outcome of this research leads to a conclusion on whether acceptance of an engagement may give rise to any conflicts of interest or independence issues with regard to the specific engagement or any other services provided to the client or target.
Two distinct basic types of potential conflicts of interest may arise.
The first basic type involves competing interests. In view of the fact that controlled auctions often attract ten or more potential buyers and only a limited number of audit firms are able to deliver the specific services, audit firms will often be approached by more than one potential bidder.
This procedure is conducted confidentially by a separate office and professionals facing clients will be informed only on a need-to-know basis.
Two potential buyers of the same target business have competing interests, but there is no direct conflict of interest, just as auditors may audit the historical financial information of two competing clients without considering their independence to be impaired. The competing interest is treated as a “perceived conflict of interest”, which can be addressed by adequate safeguards, referred to as ethical wall procedures.
Such procedures are put in place to ensure there will be no exchange of knowledge between the teams advising different buyers and may include: informing team members that ethical wall procedures apply to a specific engagement; obtaining confirmation of their understanding and adherence to such procedures; introducing physical and logical protection of all documentation against access by anyone except the client service team; and using of team-dedicated fax equipment/typing and any other measures deemed appropriate under the circumstances. Adherence to these procedures may be monitored by an independent compliance officer, if required in the specific circumstances.
Communication to clients in respect of such perceived conflicts is necessarily limited to, but very explicit in, the general statement that it cannot be excluded that the audit firm may provide similar services to other clients, which may have a competing interest. The fact that the firm actually does or does not provide services to other potential buyers, or to whom, is not disclosed, as the mere disclosure of that fact in itself may be a disclosure of confidential and commercially sensitive information.
The provision of due diligence services to a potential buyer may coincide with the audit firm being the auditor of the potential buyer. The nature of the due diligence service, ie analysis, interpretation of and comments on financial information as input for an overall evaluation of relevant aspects of a target by the client, provides the client (and indirectly its auditor) with a better understanding of the business acquired, also for accounting purposes. It is, therefore, generally accepted that providing due diligence services to an audit client does not impair the auditor’s independence except for restrictions on the level of non-audit fees versus the fees for audit services.
The second basic type of a conflict of interest is referred to as the ‘real conflict of interest’, where the interests of parties are effectively incompatible. A benefit for a buyer, a lower purchase price or more favourable contract terms, works to the disadvantage of the seller.
The audit firm might be auditor of the target or provide other services. As discussed above, the nature of due diligence procedures as such does not give rise to independence issues from the perspective of the auditor. However, the potential purchaser or target/vendor may be concerned about a potential risk of bias or breach of confidentiality obligations as a result of the interest the audit firm might be perceived to have in the outcome of the contemplated transaction.
Auditors cannot therefore, in principle, act if real conflicts of interests occur. However, the parties involved, after having been informed of the nature of the conflict, may explicitly agree that the audit firm should act on behalf of both parties. This happens frequently as parties involved value the relationship with their trusted advisors, and is an accepted practice. Obviously a potential buyer and a vendor/target will each have a dedicated team and the ethical wall measures, as agreed upon between them, will be applied.
In these circumstances the due diligence specialist will request his client to discuss and agree such matters with target/vendor. Confidentiality requirements prevent him from having direct contact himself with target/vendor or its auditor, unless explicit permission has been given by the client.
4. Outlook
The extensive discussions regarding the regulatory environment in which auditors operate has had a positive impact on the awareness and focus of parties engaging in transactions on the issue of potential conflicting interests. The way conflicts of interest are handled when due diligence and related services in general are provided is transparent to all parties involved and adaptable to all kinds of specific circumstances. Therefore, there is no need for changes in the regulations.
In view of the limited number of audit firms capable of providing due diligence services, meeting the requirements of (international) investors, a further limitation of that number by additional regulations may have a significant negative impact on market efficiency.
5. Sources
Presentatie Onafhankelijkheid, NIVRA (the Netherlands) Website: www.nivra.nl
SECTION C: LAWYERS
1. General introduction
Essential elements of the legal profession are independence, partiality (siding with the client, which includes avoiding conflicts of interest), confidentiality and integrity. These are also the rationale and the guidelines for the Dutch rules on conflict of interest.
In the Netherlands, these elements have inspired both legislation at the state level, and the regulations established by the legal profession itself through the Dutch Bar Association concerning the professional requirements for the practice of law.
The Act on the law profession (Advocatenwet, enacted in 1952) states that there will be a Dutch National Bar Association with a mandatory membership for anybody wishing to practice as a lawyer in the Netherlands. Each lawyer is thus subject not only to the specific state legislation on the legal profession, but also to the regulations adopted by the Bar Association (Nederlandse Orde van Advocaten, NOVA).
These NOVA regulations have the character of general directives (verordeningen). They are manifold, covering subjects such as the apprentice period, permanent education, requirements for financial administration, liability insurance, and partnership within the legal profession and with other professions.
The legal position of NOVA as a public body with legislative powers is only marginally checked and controlled by the Department of Justice. If the directives adopted by the legislative body of the NOVA, the council of delegates (college van afgevaardigden), do not comply with the general principles of public interest, and especially with the principles of the Act on the law profession, the minister may set them aside. This seldom happens.
The Act on the law profession explicitly stipulates that Dutch lawyers should comply with the general principles of due care, the directives set out by NOVA (Article 46) and proper professional conduct (betamelijkheid) in the assistance of clients.
These legal principles of due care and proper professional conduct have been worked out in detail in a set of deontological rules (Gedragsregels). The rules do not have the status of a directive, but are rather a fluid description of the prevailing standards related to the ethical issues. These rules are being continuously tested, and – most of the time – confirmed by the Bar Association’s own judiciary system.
The Bar Association’s judiciary system consists of five disciplinary courts of the first instance, sitting with five members, of whom one (the president) is a judge, and the other four are lawyers. There is one court of appeal, in which three of the five members are judges. This judiciary system is generally considered to be working satisfactorily.
2. Background/environment
The Netherlands has long had a well-organised national Bar, well-trained lawyers, an effective judiciary system, and steady publication in the Dutch Law Journal of deontological decisions produced by this system.
In recent decades, the climate and culture of the Dutch Bar have been changed, first by mergers between bigger Dutch firms creating, as it was then observed, big fishes in the relatively small Dutch pond; later, in the 1990s, by an Anglo-Saxon invasion that led to the commercial practices of the big firms adopting an even more business-like approach. At the same time, clients became more sophisticated, partly because their lawyers were adopting a more business-like manner.
Increasingly, the horses-for-courses strategy used by the bigger Dutch companies may create a situation in which most of the big firms are working in at least one specific area for such companies.
Probably as a result of these developments, there is now a steady traffic of partners between firms, a recent phenomenon that encourages clients themselves to change law firms.
Such developments have prompted suggestions of introducing Chinese walls within the bigger law firms or clarifying the rules in another way. Conflicts of interest issues are increasingly coming to the fore.
3. The requirements
Very recently (in June 2005) some changes were accepted by the Council of Delegates. This will be addressed below. Until this change, a provisional translation of the relevant ethical rules ran as follows (Rule 7 of the Gedragsregels):
1. A lawyer shall not engage himself in assisting two or more clients with conflicting interests or if the likelihood exists that such a conflict of interests will develop.
2. A lawyer who finds himself assisting two or more clients with conflicting interests, will, as a general principle, be obliged to withdraw completely from the case, as soon as an irreconcilable conflict arises.
3. A lawyer who has assisted in a case where two or more more clients have conflicting interests, and has withdrawn as the lawyer of one or more of these parties, shall not in a later stage act against the former client(s).
4. The above rules apply to all lawyers acting within a law firm or similar organisation. Two decisions of Dutch Disciplinary Courts illustrate the application of these rules.
Case one
Mr X (a private person) has suffered damages as a result of a fire on his premises for which his neighbour may be liable. He consults lawyer A, a member of the law firm AB. Mr X and lawyer A have a preliminary discussion of the matter, resulting in Mr X requesting lawyer A to act on his behalf in this matter. The next day, lawyer A discovers that the neighbour holds insurance from an insurance company that is a long-standing and valuable client of the firm. Lawyer A informs Mr X of this and asks his permission to discuss this with the insurance company. Mr X agrees. The insurance company confirms that it wishes law firm AB to defend the neighbour if an action is brought. Lawyer A then terminates the client relationship with Mr X. Some months later, the insurance company instructs lawyer B of the law firm AB to act on behalf of the neighbour, who has by now received a writ from Mr X. Law firm AB accepts the instructions. Mr X complains that law firm AB has been using the information that Mr X has entrusted to lawyer A.
The Disciplinary Court of the First Instance considers the conduct of lawyer B to be an infringement of the above rules on conflict of interests, because a client relationship had existed between the law firm AB and Mr X. Lawyer B is under the obligation to avoid any concern by Mr X that he might use information entrusted to his firm (albeit to another lawyer) by a former client against that very client. A formal warning is given to lawyer B.
The Disciplinary Court of Appeal is less strict. The Court of Appeal considers that the function of the rules on conflict of interests is that a client must be protected in a such a way that he can with absolute trust provide his lawyer in his client-lawyer relationship with all relevant information, which implies that he can be absolutely confident that this information is never to be used against him. The Appellate Court then rules that if it is evident and uncontested that information of confidential nature has not been entrusted to a lawyer in the relevant client-lawyer relationship, then there is no material argument to invoke this rule. In this case, it is clear and undisputed that during the very short and only introductory client relationship no relevant and confidential information was transferred to lawyer A; for that reason, the complaint is decided to be unfounded, and the first instance decision is set aside.
Case two
A big corporate client, A, is on a regular basis using the leading big Dutch law firm XY for legal services in a specific area. Another big Dutch company, B, is also a regular client of this law firm. The companies A and B become entangled in a conflict.
During injunction proceedings company A, as a claimant, instructs another law firm. Company B then asks its regular law firm XY to defend it in the proceedings.
One of the lawyers of the law firm XY accepts this instruction, and acts as the lawyer for company B against company A. Company A files a complaint that law firm XY has infringed the rules on conflict of interest by acting against one of its clients.
Here, the Disciplinary Court has formulated a general rule that any client of a law firm must have confidence that the law firm he has instructed will serve his interests exclusively. Therefore, the law firm will never act against its client “in the relevant case, in similar cases, or even in any other case”. This principle is, according to the court, justified by the principle of the confidentiality of all information ever entrusted by a client to his lawyer. It is even considered to be of general (public) interest that this confidentiality principle in the client-lawyer relationship is observed. This rule not only serves to protect the client, it also has the function of avoiding any suggestion of abuse of confidential information.
Further, it is stressed by the Disciplinary Court that this principle encompasses the whole of a law firm, even a very big law firm. The fiction of one collective memory of a law firm implies that any knowledge of any individual member of the firm is to be considered as knowledge of the firm as a whole.
In his defence, the lawyer argues that he has acted against the complaining company A, and on behalf of company B, in a case which was totally unrelated with the (only) specific area in which company A used to consult his law firm. This should, in his opinion, exclude any risk of damaging confidential information entrusted by company A to his firm being available.
The lawyer points out that it is common for the bigger Dutch companies to instruct many of the leading Dutch law firms on a regular basis and at the same time in different specialist areas. A strict application of the rule of conflict of interests would exclude all the law firms involved, an unacceptable and unpractical result.
The Disciplinary Court then admits the lawyer’s evidence that the practice area in which company A regularly consulted the law firm did not have any material connections with the area which the lawyer was now acting in against company A.
After the explanation on this issue by the lawyer the Disciplinary Court decides that he had failed to show the absence of any connection. Thus, the possibility of abuse of confidentiality is not clearly absent, and therefore the complaint is considered to be founded.
However, this decision shows some room for exceptions: if a law firm acts against one of its clients in a matter which is unrelated to the specific area(s) in which such a client is consulting the firm, and provided that there is no transfer of relevant confidential information beyond the limits of this specific area, then the law firm might consider a conflict to be absent, and could be free to act against this client.
These two cases illustrate that the essence of the rule lies in protecting the client against any risk that information which he has entrusted to his lawyer in his confidential lawyer-client relationship is used against him. Any possible concern of a client that this might happen should be avoided. Both cases show that the absence of any material risk of the abuse of confidential information and the absence of any reasonable cause for concern might enable a lawyer to accept a case against a former or even existing client. This, then, would be a matter for judgment based on facts.
4. Outlook
Recently, the Council of Delegates has discussed the question whether these rules are somewhat obsolete in the light of the recent developments in the character of, especially, the very big Dutch law firms, and the conduct of the bigger Dutch clients.
It was discussed whether there should be a more direct restriction of the rule on case-related confidential information and whether a law firm should be allowed to make restrictive agreements on this issue with the client as a condition of accepting a case (“informed consent”).
The result of the General Board’s proposals and the following discussions is that the above-quoted principles of Rule 7 remain basically the same. That is, that a lawyer may not act against a former or actual client of himself, nor may of any of his associates. But it is now added to this principle that there might be exceptions. One is the situation where the former case is totally unrelated, and no other reasons for not taking this case against this client exist. The other is that it is agreed with a client, when accepting the case, that his lawyer might act against him.
All this, however, under the ultimate deontological safeguard that using the exceptions of the rule is also consistent within the general standard of proper professional conduct.
It is too early to see where these slightly more liberal rules will lead to.
