FINS1612 W6 Lecture

8/18/2019 FINS1612 W6 Lecture

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CAPITAL MARKETS AND INSTITUTIONS

Ethics

1

Vs.



et’s consider

Ethics leading to GFC

A short review on sub-prime –

http://www.

youtube.com/watch?v=2CVqwoN5dJg

http://www.youtube.com/watch?v=2CVqwoN5dJg





So what happened?

• Non-creditworthiness people were given loans that cannot be paid back

• High risk loans were packaged into CDO and got insurance to make it high rating

• CDOs were sold to various investors

Why did they do this?

• Everybody else are doing it

• It needs to be done

• No one will get hurt

Meanwhile, all got paid well!

By mortgage brokers

By banks & structured

financiers

By insurance & creditagencies

By investment banks

Even by investors



Fast tracked to now



What happened since GFC?

• Recent significant fines for unlawful and unethical behaviour:



So, What is Ethics?

• “Ethics”

• A set of guiding moral principles or values

• “Ethical Behaviour”

•

Refers to behaviour that conforms to those values

• Both terms are often used to imply

• “good” ethics and “good” behaviour

Why “ethics” and “ethical behaviour” in especially investment industry is

“good” business?



Ethics is not a new concept

There are no new sins; the old ones just get more publicity.

Cited in Ethics and Financial Markets: The role of the Analyst by Marianne Jennings

The Code of Hammurabi for Ancient Babylon (bc. 1800):

If a builder builds a house for a man and does not make its construction firm, and

the house which he has built collapses and causes the death of the owner of thehouse, the builder shall be put to death

Tulip Speculation 1636 (Holland) –

Market bubble – Futures of tulip were traded when physical tulips were no longeravailable. It went up to 10k in present day USD. Investors took the word of those

who promised future delivery and then realised that there is no delivery. The

collapse impacted on Holland economy.



Ethics is not a new concept

Charles Ponzi (1882 – 1949)

Promised his investors 50% return within 45 days. All started with arbitrage of

coupons between Spain and U.S – bought for 1cent in Spain and redeem in U.S for

6 cents. But the arbitrage window closed. He continue to pay investors with funds

from new entrants whilst taking his usual cut.

Recent example (2009) - Bernard Madoff promised 12% return.

(1994) – Rogue Trader: The man who brought down Barings

Derivative trader Nick Leeson covered up losses up to USD1.4bn (2x the bank’s

trading capital). Brought down the oldest English bank (1762-1995)

What is the common theme here?



Aligning interests to gain trust

• Global survey by CFA Institute and Edelman Berland in 2013 revealed that trust

among institutional and retail investors has eroded.

• 48% said they do not trust financial services investors do what is right

• Only 15% has great deal of trust in investment management industry

• When it comes to the attributes that investors value the most:

• 35% said “acting in the best interest of the client”

• 17% - “ability to achieve high returns” and “commitment to ethical

conduct”

•Only 7% - “amount / structure of fees”

• Investors have moved beyond just good performance and are more interested in

“trustworthy behaviours”



Restoring trust

• First – Embrace transparency

• Clearly articulate investment success and missteps

• Disclose conflicts of interest, quickly address problems

• Fully disclose fees and impact

• Second – Demonstrate Integrity

• Resolving conflict of interest in favour clients

• Structure fees to align with clients’ risk/return objectives

• Third – Improve communication

• Communicate with clients early and often throughout investment process

• Fairly represent the investments made, risk, expenses

• Avoid ambiguity in communications



A crisis of culture

• A global survey of 382 financial services executives in Sept 2013 shows:

• Most firms have attempted to improve adherence to ethical standards

• Industry executives champion the importance of ethical conduct

• But, executives struggle to see the benefits of greater adherence to ethical

standards

• Needs to address knowledge gaps

• Lack of understanding and communication between departments

continues to be the norm

We all need to do our part



CFA Code of Ethics

• Act with integrity, competence, diligence, respect, and in an ethical manner with

the public, clients, prospective clients, employers, employees, colleagues in theinvestment profession, and other participants in the global capital markets.

• Place the integrity of the investment profession and the interests of clients

above my own personal interests.

• Use reasonable care and exercise independent professional judgment when

conducting investment analysis, making investment recommendations, taking

investment actions, and engaging in other professional activities.

• Practice and encourage others to practice in a professional and ethical manner

that will reflect credit on ourselves and the profession.

• Promote the integrity of, and uphold the rules governing, capital markets.

• Maintain and improve my professional competence and strive to maintain and

improve the competence of other investment professionals.



Standards of Professional Conduct

• There are a total of 7 standards:

I. Professionalism

II. Integrity of Capital Markets

III. Duties to Clients

IV. Duties to EmployersV. Investment Analysis, Recommendations, and Actions

VI. Conflicts of Interest

VII. Responsibilities as A CFA Institute Member or CFA Candidate



Standards of Professional Conduct



I A)

–

Knowledge of the Law

As an investment professional, your conduct is determined by

these organizations:

• Government and regulatory agencies

• Licensing agencies

• Professional associations

As a member of CFA Institute or candidate in the CFA Program,

you must

• understand and comply with all applicable laws.

• comply with the stricter of applicable law or the Code and Standards.

• not knowingly participate in any violation.

• dissociate from any violation.



Dissociation from violation

Was the activityillegal or unethical?

No I don’tknow

Yes





No I don’tknow

Yes

This is the ideal situation. If not already in place,

encourage your firm to develop and/or adopt a code

of ethics and to establish procedures for reporting

violations. Remember, sound ethics is fundamental to

capital markets and the investment profession





No I don’tknow

Yes

Ethical dilemmas are not always easy to interpret, so it's okay to

be unsure whether an activity is illegal or unethical. If you'reunsure, seek the advice of your firm's compliance department or

legal counsel. Remember, inaction combined with continued

association with those involved in illegal or unethical conduct may

be construed as participation or assistance in the illegal or

unethical activity.





No I don’tknow

Yes

If you've recognized that an illegal or unethical activity

has occurred, you must take action to avoid beingassociated with that activity

StopReportDisso-

ciate



I B) Independence and Objectivity

Avoid situations that could cause or be perceived to cause a loss of independence

or objectivity in recommending investments or taking investment action.

• Maintain your professional integrity by remaining independent and objective at

all times.

• Avoid compromising your own or another’s independence and objectivity.

• Ways in which your independence and objectivity may be compromised or

perceived to be compromised include the receipt of:

• Gifts

• Invitations to lavish events

• Tickets

• Favours

• Job referrals

• Additional compensation



I C) Misrepresentation

• A misrepresentation is any untrue statement or omission of a fact or any

statement that is otherwise false or misleading.

• To avoid misrepresentation, consider the following action items:

• Be honest about your professional credentials and your firm’s performance

• Exercise care and due diligence when relying on third-party information

• Disclose the use of external managers

• Be forthcoming with the risk and unpredictability of investments

• Acknowledge sources of ideas and materials that are not yours

Must not knowingly make any misrepresentations relating to investment analysis,

recommendations, actions, or other professional activities.



I D) Misconduct

Avoid dishonest, fraudulent, or deceitful conduct that reflects adversely on your

professional reputation, integrity, or competence.

• Trust is the epicenter of the operations of the financial market as a whole.

• Your professional reputation, integrity, and competence are the starting point

on this critical path to trust.



III

–

Duties to Clients



III A)

–

Loyalty, Prudence and Care

• What it means to have a duty of loyalty, act with reasonable care, and exercise

prudent judgment.



III B)

–

Fair dealing

• Deal with clients fairly with respect to investment recommendations and

actions.

• Recommend policies and procedures that will help to ensure that investment

recommendations or changes in prior recommendations are disseminated to

clients fairly and objectively.

• Recommend policies and procedures to ensure that all individual and

institutional clients are treated in a fair and impartial manner when takinginvestment actions.

• Some suggested actions for fair dealing compliance

• Limit the number of people involved.

•

Shorten the time frame between decision and dissemination.• Publish guidelines for pre-dissemination behaviour.

• Disseminate investment recommendations simultaneously.

• Maintain a list of clients and their holdings.

• Develop and document trade allocation procedures.



III C)

–

Suitability

• In an advisory relationship, make reasonable inquiry of your client situation to

make suitable investment recommendations.

• Document the client’s needs, circumstances, and investment objectives in an

investment policy statement.

• Client identification

• Investor objectives

• Investor constraints

• Performance measurement benchmarks

• Review and update the investment policy statement regularly.

•

Document attempts to carry out the review if circumstances prevent it.• Develop test procedures for choosing investments that include

• an analysis of the impact on the portfolio’s diversification.

• a comparison of the investment risks with the client’s assessed risk

tolerance.

• the fit of an investment with the re uired investment strate .



III D)

–

Performance Presentation

• Give a fair and complete presentation of performance information by:

• applying the Global Investment Performance Standards (GIPS), or

• without the GIPS standards:

• considering the knowledge and sophistication of the audience to

whom a performance presentation is addressed,

•presenting the performance of the weighted composite of similarportfolios rather than using a single representative account,

• including terminated accounts as part of performance history with a

clear indication of when the accounts were terminated,

• including disclosures that fully explain the performance results being

reported, and

• maintaining the data and records used to calculate the performance

being presented.



III D)

–

Preservation of confidentiality

• Maintain client confidentiality related to information

1. you receive as a result of your ability to conduct a portion of the client’sbusiness or personal affairs and

2. that arises from or is relevant to that portion of the client’s business that

is the subject of the special or confidential relationship.

• Disclose client information when

1. the information concerns illegal activities on the part of the client;

2. disclosure is required by law; or

3. the client or prospective client permits disclosure of the information.



III D)

–

Preservation of confidentiality

• What is the simplest and the most effective way to comply to Standards III (D)

• Avoid disclosing any information received from a client except toauthorised fellow employees who are also working for the client.

• If you want to disclose information received from a client that is outside the

scope of the confidential relationship and does not involve illegal activities, first

ask yourself the following:• In what context was the information disclosed? If disclosed in a discussion

of work being performed for the client, is the information relevant to that

work?

• Is the information background material that, if disclosed, will enable you to

improve service to the client?

Disregard this slide



CFA Case Study

–

Buying Lubrizol

• What happened?

• What are the ethical issues?

• If you were David Sokol and Warren Buffet, how would you do it differently?

Disregard this slide



Summary: Good ethics in finance and investment industry

• In finance and investment industry, opportunities to be unethical arise every

day.

• Ethical behaviour among investment and finance professionals is critical to

maintaining public trust

• Day-to-day dilemmas, simple questions to ask yourself:

•Does this violate the law?

• Is this honest?

• What if I were on the other side?

Conduct yourself with integrity and dignity and act ethically in all dealings

FINS1612 W6 Lecture

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