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Kim Kardashian has been making headlines these days for the usual reasons: gossiping about other celebrities, changing her look. But 18 months ago the queen of influencers – with an estimated net worth of $1.7 billion – was suffering more painful headlines, after agreeing, without admission of wrongdoing, a $1.26 million settlement with authorities US regulation for social media promotion of a cryptocurrency. Many other celebrities have since been prosecuted. The charges against them? Not fully disclosing that they were paid to promote crypto stocks.
Last week, the UK’s Financial Conduct Authority went a step further. Using his new consumer rights powers, he warned that he would prosecute so-called financial influencers (or “finfluencers”) who breach the Financial Products Advertising Act. The penalty will be up to two years’ imprisonment or an unlimited fine. The potential for abuse is vast: three-quarters of 18- to 29-year-olds trust finfluencers’ advice, according to McCann Relationship Marketing, although much of it may be marketing in disguise.
Both developments reflect how law enforcement must move quickly to keep up with the changing nature of technology, advertising and conflicts of interest (not to mention the ever-increasing power of celebrity endorsements). The underlying reasons, however, are very ancient. Scandals of mis-selling by supposedly professional financial advisers abound, especially when the incentives are distorting: just think of the £50 billion PPI scandal which led to millions of Britons buying high-commission, but completely useless insurance policies.
Everyday finance is one thing. But such conflicts of interest are also emerging in and around high finance networks. Nowhere is this more true than in the ecosystem surrounding the booming private capital sector. This $13 trillion industry thrived in the decade following the global financial crisis, as ultra-low interest rates led to aggressive acquisitions and in many cases superior investment returns.
Management teams at private equity firms are actively encouraged, even required, to co-invest in the funds they manage, on the rationale that this aligns a manager with the interests of those institutional limited partners.
The dynamic is extended to another level by companies like Goldman Sachs. Likewise, staff in their private capital division are encouraged to invest in their own funds. Access is also facilitated for bankers across the group.
Controversially the practice has also been extended to the legal community. Some US firms, notably Kirkland & Ellis (the private equity industry’s leading counsel), have allowed partners to invest hundreds of millions of dollars in funds managed by buyout groups they advise. Critics point out that having a personal financial interest in a particular investment outcome on which you have provided advice could compromise your legal duty to provide impartial advice. Professional rules prohibit accountants in the US and UK from investing in audit clients for this very reason.
Elsewhere, McKinsey has shown how such conflicts of interest can play out. The consultancy was fined $18 million by the SEC in 2021 for failing to put in place adequate controls over the potential misuse of “material non-public information” about clients by the group’s secretive internal asset fund, McKinsey Investment Office Partners. In 2016 the Financial Times revealed details of the $9.5 billion fund’s operations, but the group assured that it maintained “a rigorous policy to avoid conflicts of interest”.
Of course, the dilemma of how to best motivate people with monetary rewards extends beyond the financial sector and extends to broader business, particularly corporate boards of directors. There is no perfect answer for how to best align management and investor motivations without incentivizing an overly short-term approach on the one hand or conservatism on the other. But what is more certain is that share-based systems for non-executive directors (now the norm in the US) can distort their vision. Yes, a well-designed scheme might match their personal financial interests with the company’s long-term fortunes, but too much alignment with executives is definitely a bad thing: the best NEDs will challenge executives and provide independent advice without regard for their own interests. financial gain.
Those who provide advice, be they directors, accountants, lawyers or consultants, should stay above the fray and avoid conflicts of interest in the gray areas – and certainly not worry about keeping up with the Kardashians.
patrick.jenkins@ft.com