THE CONFLICT OF INTEREST IN THE CONTEXT OF THE BUSINESS OPERATING PROCESS – executive summary

1. Supported by: THE CONFLICT OF INTEREST IN THE CONTEXT OF THE BUSINESS OPERATING PROCESS – executive summary

2. Technical experts

3. Index Introduction 4 1. Defining elements of conflict of interest 6 2. Types of conflicts: real, potential and apparent 12

4. Introduction The national regulatory context includes many provisions related to conflict of interest, with particular reference to the governing bodies which, as is known, are the most exposed to the risk of “interference”. However, despite the interventions of the national Legislator, to date, neither private law nor public law disciplines contain a single definition of conflict of interest, and do not provide the decisions makers who are responsible for guaranteeing the proper functioning of the organizations to which they belong with operational recommendations. The discipline governing the conflict of interest is mainly outlined as follows: (i) The private law disciple, in the provisions set out in the Italian Civil Code, in particular: (a) Art. 1394 in relation to the conflict of interest regulation regarding the negotiation and the stipulation of private law contracts; (b) Articles 2373, 2391 and 2475 ter, regarding the regulation of the phenomenon related to the governance bodies of joint-stock companies and limited liability companies; (c) Art. 2629-bis, outlining the regulation related to the omission of notification of conflict of interest in the case of Managing Directors or member of the Board of Directors of companies listed on regulated markets. (ii) The public law disciple: (a) Art. 6 bis of Law no. 241/1990, regarding the obligation of the person responsible for administrative proceedings to abstain from the procedure in the event of a conflict of interest; (b) Italian Presidential Decree (DPR) no. 62/2013 “Regulation regarding the code of conduct for public employees,” which contains several provisions related to the discipline of conflict of interest (including articles 6 and 7, regarding respectively, the obligation of abstention and the duty to report imposed on public employees); (c) Law no. 190/2012 on "Provisions related to the prevention and repression of corruption and illegality in the public administration"; (d) Art. 53, subsection 14 of Italian Legislative Decree no. 165/2001 on the incompatibility and prohibition of the accumulation of positions and duties for public employees. (e) The recent art. 42 of Italian Legislative Decree no. 50/2016 (Code of Public Contracts) on “conflicts of interest,” according to which “the contracting authorities provide adequate measures to combat fraud and corruption and to identify, prevent and effectively resolve any case of conflict of interest in the execution of procurement and concession procedures, in order to avoid any distortion in terms of competition and guarantee the equal treatment of all economic operators"; (f) ANAC’s guidelines which are not yet definitively approved but relate to the "Identification and management of conflicts of interest in the procedures for the awarding of public contracts“. Therefore, it is clear that conflicts of interest are not currently regulated by dedicated primary sources. At the same time, the second level regulation (the so-called soft law) and the doctrinal production have rarely provided practical examples of the knowledge that could be applied to business operating processes of any corporate organization (e.g. procurement, selection and recruitment of employees).

5. Waived Added Value Preservation of the organization Reputation For the Organization This document aims to address the conflict of interest in the context of companies operating processes. In particular, the document details scenarios in which conflicts of interest tend to engage stakeholders who are involved in decision-making processes that have a high potential impact on operating processes. The regulation of conflicts of interest in operating processes implies the inevitable trade-off between the willingness to preserve the organization from reputational risk and the corresponding economic damage and to renounce the added value derived from a specific collaboration, service, etc. that may have resulted in benefits for the organization and its stakeholders. In any event, the advocated regulation should safeguard operating business conditions without interfering with company performance. Trade-off Company’s assets For the Stakeholders Regulation of operational conflict of interests Following the introduction, this document deals with the following topics: • Defining elements of conflict of interest; • Different types of conflict; • Some possible organizational solutions for managing and preventing conflicts of interest.

6. L’ The organization for Economic Co-operation and Development (OECD) defines a conflict of interest as: “[…] a conflict between the public duty and the private interest of a public official, in which the official’s private-capacity interest could improperly influence the performance of their official duties and responsibilities”. 1 The definition mainly refers to the public context, but is also applicable to the private one, and it addresses the following aspects: • "duties and responsibilities", which are the responsibilities and tasks entrusted by an organization (public or private) to its own "official", who is required to perform them according to the delegated authority received; • "private interest": the presence of a secondary and/or personal interest (on the part of the delegated party) that is in contrast with the primary interest and objectives of the delegating party (the organization); • "influence": the ability of the secondary and personal interest to influence the decisions of the delegated party. From a decisional point of view, the relationship between the organization and its employees can be compared to the agency relationship 2 between a "principal" and an "agent" where the former (the organization) defines its objectives and entrusts an agent (delegated entity) with a number of responsibilities ("duties and responsibilities") to pursue these objectives. The typical element that defines the agency relationship is the information asymmetry between principal and agent or, in our case, the existence of a "private interest" (or "secondary interest") attributable to the agent that may be in contrast with the objectives of the organization (“primary interest”), without the latter being aware of its existence. Under these circumstances, the consequent risk is that an agent may take advantage of his position of "trust", even without causing any unlawful conduct. The following diagram represents the presence of a secondary interest in the context of a corporate decision-making process: 1. Defining elements of conflict of interest Fig. 1 (SecondaryInterest) Constraints Goals Resources Secondary Interest Decision Makers Operating Process Output Decisions 1 OECD, Managing Conflict of Interest in the Public Sector – A Toolkit, 2005. 2 Jensen, Meckling, Theory of the firm: Managerial behavior, agency costs and ownership structure, 1976.

7. GThere are several types of secondary interests such as: financial interest, interests related to professional recognition and career advancement or interests related to social relationships. Furthermore, secondary interests tend to relate to factual circumstances connected to kinship, social, economic and legal relationships between decision-makers, the so-called “influencers” (Fig. 2), and other parties involved in the operating processes. These factual circumstances tend to manifest themselves with different levels of incidence, appearance and complexity. Therefore, they require a specific assessment in order to verify the existence of a “relevant” hypothetical secondary interest that may be in conflict with the interests of the organization. For instance, some circumstances may lead to a clear corroboration of the hypothesis (e.g. a company taking part in a tender procedure results that is owned by the spouse of a member of the awarding committee), others may require more complex analyses (e.g. the spouse of the member of the awarding committee who holds a professional position in the company participating to the tender procedure). In conclusion, the information asymmetry between principal and agent can be mitigated or removed through: A cognitive process related to factual circumstances that can be learned through declarations or notifications; A logical process based on more or less complex hypotheses regarding the existence of a conflicting secondary interest that are derived from circumstances that are declared or notified and where necessary explored in more detail. In other words, there must be an interest which “could improperly influence the performance". Therefore, the conflict of interest is a situation arising from certain factual circumstances that generate a hypothesis in relation to the presence or appearance of a secondary interest of an agent who is capable of influencing the decisions. The confirmed existence of a potential secondary interest does not imply any hypothesis related to the occurrence of an illegal conduct attributable to the agent.

8. The following table contains some insights with regard to the previous topic: • EXHIBIT 1: Assessment on the degree of influence of secondary interest on decisions • Referring to a hypothetical procurement process: • An organization (principal) has appointed internal employee (agent) to form a specific Awarding Committee; • The objective of the organization is to purchase an asset at the best price/quality ratio and taking into consideration the budget constraints and the urgency to perform the task. • Scenario A • Assume the existence of a family relationship (spouse) between a member of the Awarding Committee and the legal representative of one of the companies participating to the tender procedure. • Such circumstances (the family relationship and the professional position held) demonstrate the objective presence of a secondary interest for the member of the Committee that may lead to a conflict with the primary interest of the organization. • Therefore, this scenario does not imply any hypothesis related to the potential occurrence of an unlawful behaviour by the member of the Awarding Committee. • However, given the absence of a structured process dedicated to the disclosure of such circumstances, information asymmetries may lead to fraudulent behaviour. • INSIGHTS • Taking into consideration the same procurement process, as described above, is it possible to identify a secondary interest and a consequent conflict of interest in the following scenarios? • Scenario B: If the member of the commission and the legal representative of the company are parents of minors in joint custody, even though they have been divorced for many years; • Scenario C: If the member of the committee declares to have an habitual relationship with the spouse of the legal representative of the company; • Scenario D: If the parent of one member of the committee member has been: • a legal representative of the company; • An employee of the company, with an employment relationship lasting more than twenty years.

9. As mentioned above, the secondary interest must be able to “improperly influence the performance” of the agent. In general, the ability to influence the conduct of other entities involved in the business and/or to resist to their influences, can be defined as a form of power 3. According to the traditional classification, types and forms of power can be identified as follows 4: • Position power: the interpersonal power resulting from occupying a formal position of authority. It is based on the rules, values and beliefs usually learned in the course of the socialisation process according to which certain individuals with authority have a legitimate right to govern and influence others. In the vast majority of organizations, authority is identified and allocated in the form of a hierarchy, whereby individuals that hold a higher position are entitled to exercise their power over individuals who hold subordinated positions. • Competence power: the interpersonal power based on the possession of knowledge, experience and talent. The power of knowledge and competences is the element that legitimises an individual’s right to guide the behaviour of others and to comply with scientifically based principles. • Power of the charisma: the interpersonal power based on the possession of unique personal characteristics. This power leads peoples to think and to act like the individual assumed as the role model with whom they identify themselves. • Power of coercion: interpersonal power based on the ability to control the occurrence of side effects. It occurs when an individual induces other people to conform to his or her own desires by inspiring fear, penalising opponents, as in the case of loss of money or the assignment of undesired tasks. • Recognition power: interpersonal power based on the ability to control the allocation of desired effects. This occurs when an individual encourages other people to conform to his or her own requests through rewards or showing appreciation and, in pragmatics terms, granting promotions or assigning prestigious and pleasant tasks, etc. Within some organizations some people are defined as "influencers" who, even if not directly involved in the decision-making process, are able to influence decisions taken by other individuals. Influencers are identified by the presence of certain objective and observable forms of power such as positions power, competence power, power of coercion and recognition power. The degree of influence varies according to the form of power, its type and the complexity of the operating processes in which it is involved. The diagram illustrated below illustrates the existence of a “Secondary Interest” for an “influencer” who interferes in a decision-making process in which different stakeholders are involved. 3McMurray, Concepts of mind and intelligence in educational theory, 1975. 4 French, Raven, The bases of Social Power, 1959.

10. The following table contains some insights on the previous topic: • EXHIBIT 2: Assessment of the influence of a stakeholder in a position of power • Referring to a hypothetical procurement process: • An organization (principal) has appointed internal employee (agents) to form a specific Awarding Committee; • The objective of the organization is to purchase an asset that is the best value for money, while taking in consideration budget constraints and the urgency to perform the task. • Scenario A • Assume the existence of a family relationship (spouse) between the managing director of the contracting authority and the legal representative of one of the companies participating to the tender procedure. • The managing director of the company participating to the tender procedure is not a member of the Awarding Committee. • In this situation, the family relationship between the legal representative of the company and the managing director of the authority demonstrates the presence of a secondary interest that may lead to a conflict with the primary interest of the organization. Even though the interest is related to an individual who is not directly involved in the decision-making process, the position held by the managing director might lead to assumptions related to his or her influence, including apparent interest, with regard to the decision-making process. • INSIGHTS • Taking into consideration the same scenario in relation to the procurement process, is it possible to identify a secondary interest which is capable to influence a decision-making process and generate a consequent conflict of interest in the following cases? • Scenario B: If, several years before, the managing director of the organization has been a member of the Board of Directors of the company participating to the tender procedure; • Scenario C: If, several years before, the managing director of the organization has been an independent member of the Board of Directors of the company participating to the tender procedure; • Scenario D: If the family relationship, instead of the managing director, involved: • The Human resource manager of the company participating to the tender procedure; • The Marketing director of the company participating to the tender procedure. Fig. 2 (Influence) Secondary Interest Entities in a position of authority Constraints Goals Resources Influence Decision Makers Operating Process Decisions Output

11. As mentioned above, the conflict of interest relates to circumstances and not a particular behaviour and the existence of a secondary interest does not imply any hypothesis with regard to the existence of consequent illegal behaviour. However, certain behaviour might give rise to a conflict of interest in relation to decision-makers or influencers. Such behaviour aims to directly or indirectly influence decisions by means of gifts, favours and promises that are generally regulated by the Code of Ethics and the Code of Conduct of the organization.

12. According to the OECD document, there are 3 types of conflict of interest 5: “[…] a “conflict of interest” involves a situation or relationship which can be current, or may have occurred in the past. Defined in this way, “conflict of interest” has the same meaning as actual conflict of interest. […] By contrast, an apparent conflict of interest exists where it appears that an official’s private interests could improperly influence the performance of their duties but this is not in fact the case. […] A potential conflict of interest occurs where a public official holds a private interest which would constitute a conflict of interest if the relevant circumstances were to change in the future.” • The actualconflict of interest The actual conflict of interest is the situation in which a relevant and “objective” secondary interest of the agent has been identified and assessed, in addition to the primary interest of the principal at the time (t0) when the decisional process takes place. The complexity of identifying the actual conflict of interest is connected to the logic-inductive process that must identify an objective cause and effect relationship (not implying any presumption with regard to the agent’s behaviour) between the situation of the agent (legal or factual) and the identification of a secondary interest. The secondary interest must be assessed as “relevant”, that is, it must be capable of: threatening the impartiality and independence of decisions and behaviour6 or adversely affecting, “directly or indirectly, the honest and impartial performance of functions or exercise of power” 7. This logical and cognitive process of detecting a secondary interest from a contingent and empiric situation may sometimes be very simple and intuitive (e.g. in presence of a close family member of the agent who benefits from their decisions, it is possible to objectively deduce a relevant and objective secondary interest), but sometimes it may be complex (e.g. a previous distant employment relationship between the agent and a beneficiary of his or her current organizational decisions). Managing the conflict requires some kind of action (for example, the abstention in the decisional process of the holder of the secondary interest, or the abstention of the organization in undertaking a contractual relationship with the other party), which may be defined by law or by internal regulatory documents of the organization. As stated, the conflict of interest is a situation derived from certain circumstances (legal or factual) and is not a behaviour: being in conflict and actually abusing one's position are two different aspects of behaviour8. Therefore, an organization can identify a conflict and at the same time not take any action to eliminate it, if it doesn’t cause a breach of law. In this case, however, the organization may be compelled to objectively and unquestionably demonstrate that the conflict did not affect the decision. It should be noted that every decisional process implies discretional and subjective elements of evaluation, and therefore it may be very difficult to demonstrate the absence of any interference of the secondary interest in the pursuit of the primary interest. 2. Types of conflicts: real, potential and apparent 5 OECD, Managing Conflict of Interest in the Public Service, 2003. 6 Italian Council of State Resolution no. 667/2019. The original text is the following: “minacciarel’imparzialità e l’indipendenza”. 7 OECD, Managing Conflict of Interest in the Public Sector - A Toolkit, 2005. 8ItalianCouncil of State Resolution no. 667/2019. The followingis the original text: “Tutti i conflitti di interesse implicano percezioni o apparenze perché sono visti dalla prospettiva delle persone, che non dispongono di tutte le informazioni o in misura sufficiente per valutare i veri motivi che sottendono le decisioni, in tal senso possono essere mal interpretati gli eventi/le circostanze da parte di osservatori esterni al processo decisionale”.

13. The apparentconflict of interest According to D.F. Thompson, all conflicts of interest imply perceptions or appearances since they are seen from the perspective of people who do not have all the information or are sufficiently able to evaluate the real reasons behind decisions, so in this sense the events/circumstances may be misinterpreted by external observers in the decision-making process 9. The apparent conflict of interest is the situation in which the absence of an objective overlap between the interests of the agent and the principal at the time (t0), when the decisional process takes place, has been assessed, in spite of the perception, by the observers of the decisional process (who may be internal or external to the organization), of a secondary interest who is able to influence the decision. The apparent conflict may manifest itself in situations involving the influencers or in situations of “progressive temporal decay” of an actual conflict. The apparent conflict must be identified and managed with maximum attention because, in spite of the mere perception of a secondary interest, it implies a strong reputational risk for the organization. • EXHIBIT 3: The apparentconflict • Referring to a hypothetical procurement process: • An organization (principal) entrusted some internal individuals to assemble a specific Awarding Committee (agent); • The primary interest of the organization is to make a purchase that is the best value for money, considering the adherence to budget and the timing of the supply. • Scenario A • We assume a member of the Awarding Committee had an employment relationship for several years and until three months before the selection with one of the economic operators participating in the tender, this recent employment relationship would create the appearance of a secondary interest in conflict with the primary interest of the organization. • INSIGHTS • In the same procurement process, as described earlier, would you detect an apparent secondary interest in the following scenarios? • Scenario B: if the member of the Committee had had a brief employment relationship with the economic operator which ended: • 1 year ago; • 5 years ago; • Scenario C: if the member of the Committee had a son or daughter who is a current employee of an economic operator participating in the tender and in terms of size is considered is a large company. 9Thompson D.F., The challenge of conflict of interest in medicine, 2009.

14. The potentialconflict of interest The potential conflict is the situation which, at the time t0, shows elements that hint at a possible or probable future existence of a secondary interest at the time t1, which could create an actual or apparent conflict of interest. The concept of potentiality implies the risk of rationally understanding an infinite number of situations, which are abstractly detectable beforehand 10, if not supported by certain logical criteria. To this regard, the concept of potentiality has been defined by the Italian Accountancy Board (OIC) as the valuation of the “contingent liabilities” from which the provisions in the funds for risks and charges may arise (see OIC 31). This is a situation or condition typically related to a state of uncertainty, whose outcome depends by the occurrence of one or more future events. As defined by OIC, in order to qualify a conflict as potential, the future circumstances (t1) must have the following features estimated at the time t0: a) Be an established conflict, in that the circumstances must be linked to: i. a specific decision-based and operating business process; ii. specific decision makers and other parties; specific primary and secondary interests that are identifiable and conflicting b) existence at least possible, or the circumstances that must be noted for the certainty of a future occurrence (but with an undetermined date at the time t0) or have a significant probability of occurring (e.g. they may be linked to known elements of context, to historically verifiable events, to a series of historic data, etc.); c) unknown timing of occurrence, in that the circumstances cannot be linked to a certain date of occurrence at the time t0. Identifying potential conflicts requires an experiential and cognitive approach that is aimed at identifying the business process where the actual and apparent conflicts are typically found, in order to define hypotheses regarding what circumstances may precede its occurrence from a chronological and a logical point of view, thus providing a sign of potentiality. The potentiality of a conflict depends on the probability of evolution of the circumstances assessed at the time t0 in actual or apparent conflicts at the time t1, and may be depicted as a normal (or Gaussian) distribution curve, which allows the identification of three possible clusters: likely, possible and unlikely. As illustrated below, the function f(x) stands for the probability that a possible circumstance, assessed at the time t0, may generate at the time t1 any situation of actual or apparent conflict. The curve identifies three potentiality clusters, based upon the probability of occurrence: • likely: interval (μ-1σ, μ+1σ); • possible: intervals (μ-2σ, μ-1σ) and (μ+1σ, μ+2σ); • unlikely: intervals (< μ-2σ) and (> μ+2σ). Fig. 3 (Probability of future occurrence of an actual or potential conflict of interest) 10ItalianCouncil of State Resolution no. 667/2019. The followingis the original text: “comprendere un numero infinito di situazioni razionalmente, ma solo astrattamente individuabili a tavolino”.

15. Organizations must define their significant potentiality clusters (e.g., likely and possible, but not unlikely, events) and, on the basis of historical series and contingent experiences, may position the circumstances that generated subsequent conflicts on the normal distribution curve, thus defining their potentiality. The potential conflict is linked to a secondary interest that currently exists and although it is not relevant to the organization, it is “reasonably foreseeable” that it may become relevant in the future 11. In the audit 12 professional standards, the term “reasonable assurance” is “the level of assurance auditors are required to obtain by performing audit procedures and evaluating the resulting audit evidence when expressing an opinion that the financial statements are fairly presented in conformity with GAAP”. This “reasonable assurance” is not explicitly defined, but it is linked to a high level of assurance. Similarly, the potential conflict can be identified when it is “reasonably foreseeable” or highly probable (for example, by empirical experience or logical deduction) that the interest detected at present may become relevant in the future. Otherwise, as already stated, it may be possible to rationally understand an infinite number of situations, which are abstractly identified beforehand 13. As regards the organizational solutions for managing and preventing the conflict of interest, please see the integral version of the position paper. • EXHIBIT 4: The potentialconflict • Referring to a hypothetical procurement process: • An organization (principal) entrusted some internal individuals to form a specific Awarding Committee (agent); • The primary interest of the organization is to make a purchase that is the best value for money, considering the adherence to budget and the timing of the supply. • Scenario A • Let’s assume that one member of the Awarding Committee were a member of the family of a legal representative of an economic operator included in the Suppliers Register of the organization and not currently participating in the selection. These circumstances would have clear elements that hint at a possible or likely future existence of a secondary interest at the time t1. • INSIGHTS • In the same procurement process, as previously described, would you detect a potential secondary interest in the following scenarios? • Scenario B: if a relative of a Committee member were the owner of a business with a significant part of its revenues linked to clients operating in the organization’s sector (for example, public sector), supplying goods that the organization usually buys, but such a business was not included in the Suppliers Register of the organization; • Scenario C: if a relative of a Committee member were the owner of a business that supplied goods that were similar to those bought by the organization, but the relative never worked in the same sector of the organization (for example, public sector). 11 OECD, Managing Conflict of Interest in the Public Sector, A Toolkit, 2005. 12 PCAOB, Interim audit standards. 13ItalianCouncil of State Resolution no. 667/2019. The followingis the original text: “comprendere un numero infinito di situazioni razionalmente, ma solo astrattamente individuabili a tavolino”.

16. A.C.F.E., Report to the Nations - on occupational fraud and abuse, 2018. Italian Council of State Resolution no. 667/2019. Italian Presidential Decree (DPR) no. 62/2013. French, Raven, The bases of Social Power, 1959. Jensen, Meckling, Theory of the firm: Managerial behaviour, agency costs and ownership structure, 1976. Act of the 6th November 2012, n. 190. McMurray, Concepts of mind and intelligence in educational theory, 1975. OECD, Managing Conflict of Interest in the Public Service, 2003. OECD, Managing Conflict of Interest in the Public Sector – A Toolkit, 2005. PCAOB, Interim audit standards. Thompson D.F., The challenge of conflict of interest in medicine, 2009. Bibliography

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