Conflict of Interest - Research Paper Example

Conflict of Interest Part A Underwriting and Research in Investment A conflict of interest is defined by a situation wherein financial and other forms of consideration are potentially able to alter professional judgement and objectivity (Columbia University n.d.). Conflict of interest applies to different kinds of circumstances and behaviour and so various professions have laid down guidelines in relation to this as well as their corporate social responsibility (CSR). Conflict of interest affects the ethical practices and corporate social responsibility (CSR) of underwriters in a number of ways.

CSR is the acknowledgement of accountability not only for the financial performance of a business but also on the way in which his/her activities affect society as well as the environment. CSR has become extremely important because of the many business scandals that have occurred in the past as well as the recent financial crisis. These events impacted consumer confidence negatively as concerns abound n relation to ethics and governance (Leonard and McAdam 2003). This has resulted in new regulations resulting in changes in the way a number of professional groups conduct their business.

If carry out research for investment companies they are paid for this service. The implications of this conflict of interest on the stakeholder’s benefits are that third parties may also use this research information without the knowledge that it was prepared specifically for a particular client. In addition to that they may provide underwriting services. The provision of these services to the same customer represents a conflict of interest as the financial benefits of both are linked. This may affect the underwriter’s objectivity in carrying out research.

The alternative practices which enhance the ethical CSR practices and the course of action required for achieving this are as follows: An institution that provides both services could allow employees to specialise in one area. This will prevent them from working with the same client on both engagements. The institution could have separate business units operate from separate locations. In fact FSA (n.d.) indicates that business units could operate on different floors – this may help to reduce overhead costs.

Restrictions could also be placed on the information that can be accessed by employees in each business unit through the use of passwords. Part B Credit Assessment and Consulting Rating Agencies Conflict of interest affects credit rating agencies (CRA’s) because they provide consulting services for organisations while at the same time assess their credit rating. Credit rating agencies play a critical role in financial markets by providing credit risk information. This information is made available to issuers of securities, investors and regulators which they then use to make decisions.

Standard and Poor’s (2002) provided a report indicating the numerous functions of credit rating agencies in the US Securities Markets. This indicates that they should be of a high level of integrity, independence, objectivity and transparency. The implications of this conflict of interest for stakeholders are that CRA’s may not be objective in their assessment of risk. This became obvious in the financial crisis which erupted in 2007 when CRA’s gave AAA (triple A) ratings to institutions that failed shortly after (Crotty 2008).

The CRA’s were involved in the development of collaterised debt obligations (CDO’s) and mortgage backed securities (MBS’s) which sparked the financial crisis. These securities were downgraded between 2008 and 2009. In fact, Younglai and Lynch (2011) indicated that it was the credit rating agencies that triggered the crisis. They also made reference to the inherent conflict of interest in the business model of the credit rating agencies as they receive payment for the companies they rate.

It means that they can hardly be objective because they are dependent on these companies to stay afloat. These securities were downgraded between 2008 and 2009. As a matter of fact, shortly after the CDO’s and MBS’s were given high ratings they were soon downgraded. This meant that a number of stakeholders got burnt because of their dependence on the ratings provided by credit rating agencies. The alternative practices that are carried out at rating agencies is to separate their consultancy business from the credit rating business.

This could be done in a number of ways and could lead a higher level of credibility, including enhancing their accountability and effectiveness. In fact, Rousseau (2011) suggests three major areas of reform. They are: i. The elimination of regulatory references to ratings; ii. Developing obligatory due diligence for institutional investors in relation to the an issuers credit worthiness; iii. Disclosing relevant information on the underlying assets of an issuer. This would go a long way in reducing the level of risk in relation to conflict of interest.

References Columbia University (n.d.). Responsible Conduct of Research: Conflict of Interest. Retrieved from http://ccnmtl.columbia.edu/projects/rcr/rcr_conflicts/foundation/index.html. [Last accessed 6 January 2013] FSA. (n.d.). Case study: Managing conflicts of interest in a stockbroking and investment management firm. Retrieved from http://www.fsa.gov.uk/pages/Doing/Regulated/tcf/library/case/conflict.shtml [Last accessed 6 January 2013] Leonard, D and McAdam, R (2003) Corporate Social Responsibility.

Quality Progress, October 2003, p. 27 to 32. Rousseau, S. (2011) The Question of Credibility: Enhancing the Accountability and Effectiveness of Credit Rating Agencies. Retrieved from http://cdhowe.org/pdf/Commentary_356.pdf. [Last accessed 7 January 2013] Crotty, J. (2008) Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’. Economics Department Working Paper Series. University of Massachusetts, Amherst. Standard and Poor’s (2002).

Standard & Poor’s Ratings Services. Retrieved from http://www.sec.gov/news/extra/credrate/standardpoors.htm. [Last accessed 7 January 2013] 781943 CoI …