Self-Dealing: What it Means, Why it's Illegal, Examples

What Is Self-Dealing?

Self-dealing is when a fiduciary acts in their own best interest in a transaction, rather than in the best interest of their clients. It represents a conflict of interest and an illegal act that can lead to litigation, penalties, and termination of employment for those who commit it. Self-dealing may take many forms but generally involves an individual benefiting — or attempting to benefit — from a transaction that is being executed on behalf of another party.

How Self-Dealing Works

Self-dealing may involve many types of individuals who work under the guidelines of fiduciary responsibility. They may include trustees, attorneys, corporate officers, board members, and financial advisors, among others. Self-dealing may consist of a variety of actions seeking to inappropriately enrich oneself, such as using company funds as a personal loan, ignoring a duty of loyalty to an employer to assume a deal or opportunity for oneself, or using insider or non-public information in a stock market transaction. Self-dealing may take many forms. It does not need to always directly enrich the individual committing the act, but can be on behalf of another party.

Examples of Self-Dealing

One example of self-dealing would be if a financial advisor knowingly advised their clients to purchase financial products that were not in their best interest (such as being too expensive or unsuitable) to earn a bigger commission. Some other examples include:

• If a broker received a sell order for stocks from a client but sold their shares of that same company before selling their client's shares.
• If a partner in a business pursued an opportunity that was meant for the partnership as a whole and did not tell the other partners.
• If the officer of a company only awarded a contract to a vendor under the condition that the vendor provides an internship to the officer's child.
• If an editor in charge of producing and managing a website outsourced some tasks to a company they partly owned on the side at a higher-than-necessary price and did not inform management.

Self-Dealing With Nonprofits

As it relates to nonprofits, self-dealing is written into the United States Code (26 U.S.C. § 4941). The Internal Revenue Service (IRS) is permitted to impose a 10% and 5% tax on each act of self-dealing committed by a disqualified person with a private foundation. A disqualified person may be a trustee, director, officer, relative, or key contributor to the foundation, among others. Prohibited under the rule are transactions that include loans, leases, sales, exchanges, some types of compensation, and transfer of assets to a disqualified person. For more information, the IRS guide on self-dealing has useful information on specifics.