I submit that people tend to get more upset over the exploitation of personal conflicts of interest than the institutional sort. That is to say, our blood boils when we learn of another person contravening a duty in order to gain financially, yet we don’t mind when a CPA firm falsely gives a qualified opinion on an audit so the company being audited will continue with that audit firm the following year. Logically, as the money involved is more in the case of the CPA firm and individuals within the firm stand to benefit personally as the firm is enriched by the continued business, yet even so, we cannot stand direct personal enrichment resulting from a conflict of interest. In August, 2016, Apollo Global, a large private equity firm, settled with the SEC. Both personal and institutional conflicts of interest brought on the $53 million fine. Hence, this case is useful in comparing the two sorts of conflicts of interest.
The S.E.C. accused the private equity firm of misleading investors and failing to supervise a senior executive who was twice caught “improperly charging personal items and services” to Apollo’s funds (and, by extension, to the investors). Misleading investors here is an institutional conflict of interest because the activity is 1) systemic in an organization rather than being done by a person and 2) premised on the institutional relationship between the investor class and the firm. A person improperly charging personal items constitutes a personal conflict of interest because the individual’s personal gain is put before the person’s obligation to the company. In both cases, a narrower gain supplants a wider benefit, which in turn is usually associated with a duty.
The misleading of investors involves the private equity firm’s failure to inform its investors of “so-called monitoring fees.” Apollo had been charging the fees to some of the companies it owned as compensation for the consulting and advice it had provided to them. The Apollo executives were essentially breaking out the supervisory aspect of owning a company and charging the latter for it. In short, Apollo was charging some of its companies for being owned. The private equity firm was even accelerating the monitoring fees when one of its companies was about to be sold or gone public. Specifically, “Apollo would accelerate the remaining years of monitoring fees into lump-sum payments.” According to the S.E.C., these payments effectively reduced the “amounts available for distribution to fund investors.” Apollo, and therefore its management, stood to gain. This represents a narrowing of the beneficiary group (from the companies and the fund’s investors to Apollo itself) by exploiting the fund’s duty to inform its investors. This is known as an exploitation of a conflict of interest.
Regarding the personal conflict of interest, one of Apollo’s senior executives submitted “fabricated information to Apollo in an effort to conceal his conduct” from 2010 to mid-2013. The SEC charged Apollo’s management with knowing of the manager’s misconduct yet failing to do anything about it. In charging the fund for personal items, the manager gained personally, while the fund paid the price. Hence, here again the narrowing of a benefit is involved. The manager exploited his duty to report only work-related expenses in order to gain personally.
Which conflict of interest here aggravates you more? Another person enriching himself—stealing, in effect—or the fund’s charging its companies for functions that are part of ownership and misleading investors about it? I contend that most people would say the former, even though the misleading of fund investors has been a recurring problem. “A common theme in our recent enforcement actions against private equity firms is their failure to properly disclose fees and conflicts of interest to fund investors,” said Andrew Ceresney, the S.E.C.’s head of enforcement.[vi] Ceresney could cite the Blackstone Group and Kohlberg Kravis Roberts & Company as just two such cases.
I submit the following explanation. We humans are more easily resentful of other people enriching themselves unethically than of organized groups of people doing the same thing institutionally. A person found stealing raises our ire more than a company found misleading investors so to profit more at their expense. Something about groups and institutionalization mitigates our reactions. As a result, better legislation and improved regulatory enforcement oriented to breaking up institutional conflicts of interest (even before they are exploited!) find insufficient political will. The Dodd-Frank financial reform law of 2010, coming on the heels of a major financial crisis, thus leaves the CPA and rating company conflicts of interest in tact. We can expect, likewise, that private equity firms will continue to be tempted to exploit their conflicts of interest even as individual managers found to be stealing from the company "trough" will face prosecution. I contend that American society, including its business sector, could do worse than regard institutional conflicts of interest as more rather than less harmful than the personal variety.
1. Ben Protess, “Apollo Global Settles Securities Case as S.E.C. Issues $53 Million Fine,” The New York Times, August 23, 2016.