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Conflict of interest at the heart of negative financial outcomes

12 January 2021 Gareth Stokes

Citizens in Western democracies are pawns in a system that places profit over individual wellbeing. We are unfaltering slaves to the doctrine of capitalism and worshippers of phrases such as ‘free market’ and ‘capital accumulation’. Capitalism is an economic and political construct in which a country’s trade and industry are controlled by private owners, for profit. Nowhere is this system better illustrated than in the United States (US), where private owners of trade and industry have become obscenely wealthy in recent years. How wealthy, you ask?

US$10 billion per day

As we penned this piece, the online media was celebrating a change at the top of the Forbes’ Real Time Billionaires List. Elon Musk, a South Africa-born entrepreneur and founder of electric car maker Tesla Inc, overtook Jeff Bezos, founder of Amazon.com, as the world’s wealthiest man. Musk’s fortune moved past US$187 billion on the morning of the 7th of January 2021. The top five individuals on the list were worth a combined US$680 billion; but their personal fortunes ebb and flow on a daily basis in line with investor sentiment towards their primary commercial interests. A 5% move in Tesla shares, for example, would add or subtract around US$10 billion from Musk’s net worth at current prices. 

The average blue- or white-collar workers who are key components of the consumer-driven capitalist society can only dream of becoming this wealthy. Instead, they are compartmentalised as low, middle or high income earners, and trapped in the day-to-day grind of finding jobs that pay enough to cover monthly outgoings and save for retirement. A fortunate few, thanks to their education or inter-generational wealth, belong to the so-called upper crust of High Net Worth (HNW) individuals. The hurdle to join the HNW class is highly subjective. It is common to categorise a South African with a net worth exceeding US$1 million in this category. But to level up to the super wealth class requires an average net worth of ZAR223 million, per the latest Cap Gemini World Wealth Report. 

Discussions about HNWs and the super wealthy often lead to questions about asset and income disparities within countries. Recent data published by the US Federal Reserve confirms the growing wealth and inequality gap in the world’s dominant economy. Their Distribution of Household Wealth in the US for Q2 2020 revealed that the top 1% of Americans, some 3.3 million people, had a combined net worth of US$34.2 trillion, equivalent to 30.4% of all household wealth in that country. The poorest 50% of the population, some 165 million individuals, owned just 1.9% of the wealth. 

Income and wealth disparities exist in most Western democracies. The International Monetary Fund (IMF) reveals, for example, a highly skewed income distribution in South Africa, where “the top 20% of the population holds over 68% of income while the bottom 40% holds just 7% of income”. There are countless reasons why South Africa’s income inequality is more pronounced than that of its emerging market peers, but these are out of scope for this article. 

The consequences of chasing profit

It is difficult to quantify the middle income segment because it varies from one country market to the next. In South Africa we think of households that have after-tax incomes of between ZAR6500,00 and ZAR45000,00 per month. Suffice to say there is fierce competition among individual employees to progress towards the higher end of this band and, hopefully, break through the ceiling to join the high income crowd. This desire for self-improvement perpetuates the capitalist paradigm and explains why many individuals play fast and loose with morality when money is on the line. It also explains why profit rather than common sense drives human behaviour. 

Private sector companies exist to generate wealth for their owners. Small companies are usually owned by a handful of co-owners or shareholders whereas larger firms listed on public exchanges can have hundreds or thousands of shareholders. The goal is for private companies to maximise the return or profit paid to their shareholders and firms are structured to reward employees for decision-making that achieves this. Both blue- and white-collar staff are incentivised through pay hikes and cash bonuses following a profitable year. Management and executive teams benefit from multiples of these cash bonuses alongside a range of lucrative stock options. A PwC Report into executive remuneration to end-February 2020 shows that the CEOs of the 10 largest JSE-listed companies earned a median salary of R23.6 million. 

Introducing conflict of interest

Website Wikipedia.org describes a conflict of interest as “a situation in which a person or organisation is involved in multiple interests, financial or otherwise … where serving one interest could involve working against another”. Conflicts typically stem from a person or organisation chasing profit without regard to the negative consequences their actions may hold for other stakeholders. The financial services industry is the prefect playground to study how an obsession with profit drives conflict. Regulators have spent years trying to stamp out conflicts in the financial sector, with clear guidelines contained in the Financial Advisory and Intermediary Services Act and its accompanying regulations. Among other requirements, financial services providers must publish conflict of interest policies… 

An example of such, courtesy Bidvest Insurance, describes conflict of interest as “any situation in which a financial services provider or a representative has an actual or potential interest that may, in rendering a financial service to a client, influence the objective performance of his, her or its obligations to that client; or prevent a financial services provider or representative from rendering an unbiased and fair financial service to that client or from acting in the interest of that client. Conflict of interest, they write, can arise from a financial interest, for example, the adviser receiving an incentive that results in one financial product being preferred over another more suitable product; from an ownership interest, wherein an adviser owns a share of the company whose products are recommended; or other third party relationships. 

Undermining the public good

The profit obsession creates conflicts in unexpected corners of the business world. One might imagine, for example, that government funding to help South African businesses to survive the coronavirus pandemic would be free of profit concerns. The terms and conditions for small businesses to receive loans, on favourable terms, were well-documented; but government erred in putting its faith in South Africa’s large commercial banks to disburse these funds. Their error exhibited in the conflict of interest between banks’ profit motive and the social obligation of rescue funding. 

Struggling small, medium and micro enterprises (SMMEs) had no choice but to apply for emergency funding through their banks; but the banks were incapable of setting aside their commercial lending practices when processing applications. Instead of providing emergency funding in a timely fashion, banks conducted broad assessments of their SMME client’s existing borrowing facilities with a view to limit the impact of cheap rescue loans on the banks’ ongoing profitability. What good is a favourable loan if the SMME has to wait six months for approvals or is prevented from using the relief funding to offset other costlier borrowing facilities? 

Food and tobacco versus health

Readers keen on a more sinister assessment of conflict of interest would benefit from watching the Netflix documentary Game Changers. This documentary uncovers the underpinnings of grand scale conflicts in the global food and tobacco industries wherein the interests of sponsors are placed ahead of those of consumers. The film describes a world where firms with the deepest pockets control the narrative… They conclude that food and tobacco majors are / were party to the ultimate conflict of interest, putting profit before life, and using their abundant revenues to manufacture science.

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