Fiduciary duties, conflict of interest, and proper exercise of judgment.

Author:Valsan, Remus

One of the foremost problems of fiduciary law theory is the imprecise understanding of what a situation of conflict of interest involves. The mainstream contemporary legal literature on fiduciary duties is premised on the dual assumption that, on the one hand, humans are inclined to act self-interestedly and, on the other hand, they are too weak to consciously resist this urge while managing another person's interests. Although these assumptions may be true in many cases of breach of fiduciary duties, they do not suffice to explain why fiduciary duties are imposed in situations where a fiduciary's good faith and honesty cannot be questioned. This article proposes a novel understanding of the notion of conflict of interest. Building on insights from cognitive psychology, behavioural economics, and philosophy, this article defines a conflict of interest as the situation where a person, who has a duty to exercise judgment for the benefit of another, has an interest that tends to interfere with the proper exercise of his or her discretion. The emerging interdisciplinary theory of conflicts of interest shows that personal or extraneous interests interfere with a decision maker's judgment in unpredictable ways, despite the decision maker's honest efforts to keep them aside. This theory offers a more persuasive rationale for the strictness of fiduciary liability. It also offers a potent argument against the recent calls to relax the strict fiduciary regime in commercial contexts.

L'un des problemes les plus importants de la theorie du droit fiduciaire est la meconnaissance des implications qui decoulent d'une situation de conflit d'interets. La litterature juridique contemporaine dominante sur les obligations fiduciaires repose sur le double postulat que, d'une part, les humains sont enclins a agir dans leur propre interet et, d'autre part, ils sont trop faibles pour resister a cet instinct de facon consciente tout en ayant l'obligation d'administrer les interets d'une autre personne. Bien que ees postulats puissent etre fondes dans de nombreux cas de violation des obligations fiduciaires, ils ne suffisent pas a expliquer pourquoi des obligations fiduciaires sont imposees dans des situations ou la bonne foi et l'honnetete d'un fiduciaire ne sont pas remises en question. Cet article propose une nouvelle conception de la notion de conflit d'interets. Utilisant des notions provenant de la psychologie cognitive, de l'economie comportementale et de la philosophie, cet article definit un conflit d'interets comme une situation dans laquelle une personne, ayant le devoir d'exercer son jugement pour le profit d'autrui, a un interet qui tend a interferer avec le bon exercice de son pouvoir discretionnaire. La theorie emergente et interdisciplinaire sur les conflits d'interets demontre que les interets personnels ou externes interferent avec le jugement d'un decideur de facon imprevisible, malgre les efforts honnetes du decideur de les tenir a l'ecart. Cette theorie propose une justification plus probante pour la nature stricte des regimes actueis de responsabilite fiduciaire. Elle offre egalement un argument robuste contre les demandes recentes d'assouplir ce regime fiduciaire strict dans des contextes commerciaux.

Introduction I. The Dominant View on the Content and Rationale of Fiduciary Duties A. When Do Fiduciary Duties Alise? B. What Are Fiduciary Duties? C. Why Are Fiduciary Duties So Strict? 1. The Deterrence Argument 2. The Vulnerability Argument 3. An Evaluation of the Deterrence and Vulnerability Arguments II. From Conflict between Interest and Duty to Conflicting Interests: A Historical Overview A. Eighteenth-Century Justifications for the Strictness of the Proscriptive Duties B. Nineteenth-Century Justifications for the Strictness of the Proscriptive Duties C. Conflict between Interest and Core Fiduciary Duty in the Twentieth-Century Case Law III. Conflict of Interest and Proper Exercise of Judgment An Interdisciplinary Approach A. The Emergence of an Interdisciplinary ? Theory of Conflicts of Interest B. The Content of the Interdisciplinary Theory of Conflicts of Interest IV. The Relevance of the Interdisciplinary Theory of Conflict of Interest to the Law of Fiduciary Duties A. The Duty to Exercise Discretion Based on Relevant Considerations B. Preserving the Strictness of the Proscriptive Fiduciary Duties C. Addressing Conflicts of Interest: The Shortcomings of Resistance and Disclosure Conclusion Introduction

John Byng was a well-reputed admiral of the English Royal Navy. In 1756, he was defeated by the French naval fleet in the battle for the Mediterranean island of Minorca. Although Admiral Byng had notified his superiors of the multiple causes of his failure (including insufficient military personnel, damaged ships, and failed communications), public outrage demanded that Byng bear the blame. The following year, Byng was court-marshalled, accused of "not do[ing] his utmost" to prevent Minorca from falling to the French navy, and executed by firing-squad. (1) Byng's scapegoat execution led Voltaire to remark sarcastically: "[D]ans ce pays-ci [l'Angleterre] il est bon de tuer de temps en temps un amiral, pour encourager les autres." (2)

Surprisingly, the practice that triggered Voltaire's ridicule more than two centuries ago is nowadays invoked by courts and established fiduciary law scholars as the main justification for the onerous proscriptive duties that bind persons occupying a fiduciary position. In a recent decision of the England and Wales Court of Appeal, for example, Lady Justice Arden explained the severity of the proscriptive fiduciary duties by invoking the need to discipline fiduciaries, Admiral Byng-style:

It may be asked why equity imposes stringent liability ... [E]quity imposes stringent liability on a fiduciary as a deterrent--pour encourager les autres.... [I]n the interests of efficiency and to provide an incentive to fiduciaries to resist the temptation to misconduct themselves, the law imposes exacting standards on fiduciaries and an extensive liability to account. (3) The view that strict duties are necessary in order to deter and discipline all fiduciaries is very common in fiduciary law literature. Robert Flannigan, for instance, contends that only an undiscriminating "sledgehammer" approach to conflicts of interest can eliminate fiduciaries' incentives for opportunistic manipulation. (4) Gareth Jones, another outstanding equity scholar, has a similar, although more nuanced, view. He argues that, exceptionally, courts should be able to compel honest fiduciaries to disgorge unauthorized gains in order to punish them, pour encourager les autres. (5)

The argument that the law must impose onerous proscriptive duties on all fiduciaries, regardless of their honesty, in order to deter them from succumbing to the temptation of easy gains is counterintuitive and cannot be easily accommodated within many influential frameworks of private law. This article offers a novel justification for the peculiar strictness of fiduciary duties, which is based on a more precise understanding of the notion of conflict of interest. The starting point of many fiduciary theories is that, because the fiduciary has scope for the exercise of power or discretion and is tempted to act self-interestedly, her self-regarding interests come into conflict with the beneficiary's interests. Yet, equating this understanding of conflicting interests with the notion of conflict of interest is an error that has obstructed efforts to identify the proper role of the proscriptive duties and the underlying core features of all fiduciary relationships.

Building on insights from cognitive psychology, behavioural economics, and philosophy, this article defines a conflict of interest as a situation in which a person, who has a duty to exercise judgment for the benefit of another, has an interest that tends to interfere with the proper exercise of her discretion. Conflict of interest situations affect the reliability of the decision maker's judgment in ways that cannot be measured or corrected adequately. This theory offers a sound explanation for the peculiar harshness of fiduciary duties. The central reason for the strictness of fiduciary duties is not to prevent the temptation to steal or shirk, or to discipline the market, as the prevailing justifications hold, but rather to prevent self-interest or other-regarding interests from interfering with the fiduciary's core duty to exercise judgment based on relevant considerations. The proscriptive duties thus protect the beneficiary's right to the fiduciary's best judgment by preventing self-interest or other-regarding interests from interfering with the fiduciary's proper exercise of judgment.

The article proceeds as follows. Part I outlines the current legal framework of fiduciary duties, with a focus on the content of these duties and the shortcomings of the main theoretical justifications for their strictness (namely, the deterrence and vulnerability arguments). (6) Deterrence and vulnerability are unconvincing explanations because they misunderstand what lies at the core of a conflict of interest situation. That is, they focus on the opposing interests between the parties to a fiduciary relationship, rather than on the conflict between the fiduciary's interests and her core fiduciary duty to exercise proper judgment. Part II shows that the current misunderstanding of what a conflict of interest situation entails goes back to the early stages in the development of fiduciary law. It will also show that the notion of conflict of interest proposed in this article existed in the early stages of fiduciary jurisprudence, but was eventually overshadowed by the conflicting interests justification of the strictness of fiduciary duties. Part III demonstrates that the emerging interdisciplinary theory of conflicts of interest validates the notion of conflict of interest put forward in this...

To continue reading