Businesses and financial markets thrive on trust.

Top two attributes of an investment manager-

1. Has transparent and open business practices
2. Has ethical business practices.

Throughout our lives and careers we will encounter situations in which there is no definitive rule that specifies how to act, or the rules that exist may be unclear or even in conflict with each other.

Investment professionals must be willing and able to identify potential ethical issues and create solutions to them even in the absence of clearly stated rules.

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Ethics

Learning Outcomes

• Explain Ethics

Through our individual actions, each of us can affect the lives of others.

Our decisions can harm or benefit a variety of stakeholders.

In some cases, our actions may benefit only some stakeholder groups and harm others.

This can vary over the short term or long term.

Ethics encompasses as set of moral principles and rules of conduct that provide guidance for our behaviour.

Beliefs are assumptions or thoughts we hold to be true.

A principle is defined as a belief or fundamental truth that serves as the foundation for a system of belief or behaviour or a chain of reasoning.

Our beliefs form our values.

Moral principles or ethical principles are beliefs regarding what is good, acceptable, or obligatory behaviour and what is bad, unacceptable, or forbidden behaviour.

Ethical conduct – behaviour that follows moral principles and balances self-interest with both the direct and indirect consequences of the behaviour on others.

Ethical actions – actions that are percieved as beneficial and conforming to the ethical expectations of society.

• example: telling the truth about the risks and costs associated with a recommended investment is an ethical action.
  • telling the truth is also beneficial since it builds trust with the client, and can lead to better customer satisfaction

Widely acknowledged ethical principles:

1. Honesty
2. Transparency
3. Fairness or justice
4. Diligence
5. Respect for the rights of others.

An investment advisor who is required by law to act in a client’s best interest must understand the client’s financial objectives and risk tolerance, research and investigate multiple investment opportunities, and recommend the investment or investment portfolio that is most suitable for them in terms of meeting their long term financial objectives.

• In addition the investment advisor would be expected to monitor the client’s financial situation and investments to ensure that the investments recommended remain the best overall option for meeting the client’s long term financial objectives.

In countries with only a suitability requirement, it is legal for clients to recommend a suitable investment even if other, similar investments that have lower expense ratios are available.

Societal groups and communities codify their beliefs about obligatory and forbidden conduct in a written set of principles, often called a code of ethics.

• Universities, employers, professional associations often adopt a code of ethics to communicate the organisation’s values and overall expectations.

Some communities expand their code of ethics to adopt explicit rules or standards that identify specific behaviours required of community members.

• Standards of conduct – serve as benchmarks for the minimally acceptable behaviour of community members and help clarify the code of ethics.

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Ethics and Professionalism

Learning Outcomes

• describe the role of a code of ethics in defining a profession
• describe professions and how they establish trust
• describe the need for high ethical standards in investment management
• explain professionalism in investment management

Profession is an occupational community that has specific education, expert knowledge, and a framework of practice and behaviour that underpins community trust, respect, and recognition.

In most countries, those who work in specialized areas are subject to licensed status and technical standards.

Differences between professions and trade bodies/ craft guilds

1. requirement for professionals to uphold high ethical standards
2. trade bodies often do not have a mission to serve society or set and enforce professional conduct rules for practitioners.

How professions establish trust

1. Professions normalize practitioner behaviour: Regulators typically support professional ethics and recognize the framework for ethics that professions can provide. Codes and standards developed by practitioners can be complimentary to regulations. Many governments recognize that a profession can develop a more sophisticated system of standards than a regulator can.
2. Professions provide a service to society: obligation for professionals to go beyond codes and standards individually and through their companies.

Earning trust not only creates professional pride and acceptance in the community, but also commercial benefits.

• Professions are client focused: at a minimum, professionals must act in the best interest of their clients.

The obligation to deliver a high standard of care when acting for the benefit of another party (ie- on behalf of the client) is called fiduciary duty.

• Professions have high entry standards: they develop curricula that equip future professionals with competence, including technical skills, knowledge, and ethics.

1. Professions possess a body of expert knowledge: a repository of knowledge developed by skilled professionals helps members work effectively and ethically.
2. Professions encourage and facilitate continuing education: after qualification and throughout their career, there will be changes in knowledge and technical skills. Important to keep upskilling and often required as a condition to do so to remain as an active member.
3. Professions monitor professional conduct: members must be held accountable for their conduct to maintain integrity and reputation of an industry.
4. Professions are collegial: professionals should be respectful to each other.
5. Professions are recognized oversight bodies: Most professional bodies are NGOs with a mission.
6. Professions encourage the enegagement of members: participation and interaction as volunteers is part of the essence of a profession. A good professional will want to mentor and inspire others.
7. Professions are evolving: As time changes, so do professions. Individuals responsibility to keep up and adhere to the changing standards.

Professionalism in investment management

Successful investing professionals are disciplined and consistent and they think a great deal about what they do and how they do it.

—Benjamin Graham, The Intelligent Investor (1949)

Investment management is a relatively young profession → public understanding of its practice and codes is still evolving.

Not everyone engaged in investment management is a professional.

Trust in investment management

investment managers are trusted to draw from a body of formal knowledge, and apply that knowledge with care and judgement.

investment professional are expected to have:

• superior financial expertise
• technical knowledge
• knowledge of the applicable laws and regulatins

Investment professionals must fully disclose:

• conflicts of interest
• risks
• fees involved

compliance with code of ethics and professional standards is essential, and practice must be guided by care, transparency, and integrity.

In most countries, skilled evaluation of securities leads to more efficient capital allocation and, in combination with ethical corporate governance, can assist in attracting investment from international investors.

The investment management profession can deliver more value to society when higher levels of trust and better capital allocation reduce transaction costs and help meet client objectives.

When client interests and market interests coflict, the Code of Standards set an investment management professional’s duty to market integrity as the overriding obligation.

CFA Institute Global Body of Investment Knowledge (GBIK) and Candidate Body of Knowledge (CBOK) are updated on an ongoing basis using practice analysis

• interactions with practicing investment management professional, ensuring that the body of knowledge remains current and globally relevant.

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Challenges to Ethical Conduct

Learning Outcome

• identify challenges to ethical behavior

We may find ourselves in unfamiliar situations where an appropriate course of action is not immediately clear

-OR-

There may be more than one seemingly acceptable choice.

Studying ethics helps us prepare for such situations.

Challenges to ethical behaviour

1. People tend to believe that they are ethical people and that their ethical standards are higher than average.
   1. Overconfidence, a common behavioural bias can lead to faulty decision-making
   2. Our beliefs and emotions frequently interfere with our cognitive reasoning, and result in behavioural bias
   3. As a result of the behavioural bias, we are more likely to overestimate the morality of our own behaviour, especially in situations we have not faced before.
   4. Overconfidence bias leads us to place too much importance on internal traits and intrinsic motivations.
2. Situational influences (such as what other people around are doing)
   1. Situational influences are external factors, such as environmental or cultural elements that shape our thinking.
   2. when put in difficult situations, even good people with honorable motives can be influenced to do unethical things.
   3. people who consider themselves as strong, independent, free thinkers will conform to social pressures in many situations.
      1. Example (bystanders in an accident tend to not take action and help but just watch when others are present- waiting for someone else to help rather than doing it themselves)
   4. Situations can also induce people to act more ethically.
      1. People tend to behave more ethically when they think someone else is watching (cameras in a building)
   5. Situational influences have a very powerful and often unrecognized effect on our thinking.
   6. learning to recognizee situational influences is critical to making good decisions.
   7. Common situational influences in the investment industry:
      1. money
      2. prestige
      3. loyalty
      4. promotions
   8. Large rewards, bonuses, in the investment industry and motivate individuals to act in their own short-term self interest.
   9. Loyalty to supervisors or organizations, fellow employees, and other colleagues can tempt individuals to make compromises and take actions they would reject under different situational influences or judge harshly when taken by others.
   10. Our brains easily and quickly identify short term situational influences than longer term considerations (such as maintaining our integrity, and contributing to the integrity of the financial markets).
   11. When our decision-making is too focused on short term factors we ignore/minimize longer term risks/consequences to ourselves and others.
3. Loyalty to employer and/or colleagues is an extremely powerful situational influence.
   1. our colleagues can influence our behaviour in both positive and negative ways.
   2. Well intentioned firms develop strong compliance programs to encourage adherence to rules, regulations, and policies.
   3. A strong compliance policy is a good start to start developing an ethical culture (BUT focus on adherence to rules may not be sufficient).
   4. A compliance approach may not encourage decision makers to consider the larger picture and can oversimplify decision making.
   5. A strong compliance culture can become another situational influence that blinds employees to other important considerations.
   6. employees might adopt the ‘check the box’ mentality rather than ethical decision-making approach.
   7. Employees might ask ‘what can I do’ rather than ‘what should I do.

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Ethical vs. Legal Standards

Learning Outcome

• compare and contrast ethical standards with legal standards

Laws and regulations often codify ethical actions that lead to better outcomes for society or specific group of stakeholders.

Complying with the rules laid out by laws and regulations is considered an ethical action.

• It creates a more satisfactory outcome that conforms to stakeholder’s ethical expectations.

Eg:- disclosure requirement for the risks of investing (you come across this a lot in real life)

• Complying with this rule leads to better outcomes for your clients, and your employer

How?

1. Compliance with the rule reduces the risk that clients will invest in securities without understanding the risk, which in turn reduces the risk that the client will file complaints or take legal action
2. Complying with the rule also reduces the risk that regulators will initiate an investigation, file charges, or sanction you or your employer.

Conduct that reduces these risks would be considered ethical.

Why?

Because it leads to better outcomes for you, your clients, and your employer, while complying to the ethical expectations of various stakeholders.

IMPORTANT:

Although laws frequently codify ethical actions, legal and ethical conduct are not always the same.

Many types of conduct are both legal and ethical, but some conduct may be one and not the other (Diagram below)

Investment industry has some examples-

• Insider trading (trading with material non-public information) is legal in some countries, but it is considered unethical by CFA and many investment professionals.
• Whistleblowing (disclosing of dishonest, illegal, or corrupt activity by individual or government) on the other hand may violate local laws or organizational policies, but some consider it to be ethical.

The law is not always the best mechanism to reduce unethical behaviours for several reasons:

1. Laws follow market practices. (regulators may proactively design laws and regulations to address existing or anticipated practices that may adversely affect the fairness and efficiency of markets or reactively design laws and regulations in response to a crisis or an event that resulted in significant monetary losses and loss of confidence/trust in the financial system)
2. Regulator’s responses typically take significant time, during which the problematic practice may continue or even grow.
3. Once enacted, a new law may be vague conflicting or too narrow in scope.
4. Laws vary across countries and jurisdictions, allowing questionable practices (such as insider trading) to move to places that lack laws relevant to the questionable practice.
5. Laws are subject to interpretation and compliance by market participants, who may choose to interpret the law in a more advantageous way, or delay compliance until a later date.

Ethical behaviour goes beyond what is legally required.

Ethical behaviour encompasses what different societal groups or communities consider to be ethically correct behaviour.

To act ethically, individuals need to be able to think through the facts of the situation and make good choices even in the absence of clear laws or rules.

Ethics requires judgement.

Good ethical judgement requires actively considering the interests of stakeholders and trying to benefit multiple stakeholders, and minimize risk, including reputational risk.

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Ethical Decision-Making Frameworks

Learning Outcome

• describe a framework for ethical decision making

Individual judgement is critical ingredient in making principled choices and engaging in appropriate conduct.

Strat to increase trust in the investment industry → increase the ability and motivation of market participants to act ethically and help them minimize the likelihood of unethical actions.

Investment professional’s desire to do the right thing can be reinforced by building a culture of integrity and accountability in the workplace.

Having a code of ethics is a good first step to do so, but it is insufficient on its own.

Teaching, and practicing ethical decision-making skills is the way to go.

A strong ethical culture, built on a defined set of principles, that helps honest, ethical people engage in ethical behaviour will foster investor trust, lead to robust global financial markets, and ultimately benefit society. (Butterfly effect)

The Framework for Ethical Decision-Making

Investment professionals are good at analyzing and making decisions from an profit/loss point of view.

• it is also important to analyze decisions and their potential consequences from an ethical perspective.

Ethical decision making framework will help decision maker see the situation from multiple perspectives and pay attention to aspects of the situation that may be less evident with a short term self-focused perspective.

The goal of getting a broader picture of a situation is to be able to create a plan of action that is less likely to harm stakeholders and more likely to benefit them.

for this the decision-maker needs to understand the consequences of his/her actions on the stakeholders.

General Ethical Decision Making Framework

1. Identify: relevant facts, stakeholders and duties owed, ethical principles, conflicts of interest (duty to client may conflict with duty to employer, but duty to client prob comes first).
2. Consider: Situational influences, additional guidance (seek opinions of trusted people- critical step to view things from different perspectives), alternative actions
3. Decide and act
4. Reflect: Was the outcome anticipated? Why or why not?

Ethical decision making process has many phases, and many components.

The process is often iterative.

The decision maker may move between phases in an order from what is presented.

2- Consider- people you can turn to for additional guidance:

• Family member
• Colleague
• Mentor
• Compliance department
• Legal counsel

Should seek guidance from someone external to the firm who is not affected by the same situational influences and behavioural biases, and hence provide a fresh perspective.

Helpful technique is to think how an ethical peer or role model might act in a given situation.

Applying the framework

• there were a couple case studies. need to refine learning and keep on learning more.

An ethical decision making framework is a tool for analyzing the potential alternative actions and consequences of a decision.

Ethical decision making frameworks raise awareness of different perspectives

Ethical decision making frameworks can help reduce unanticipated ethical lapses and unexpected consequences.

The financial advisor should put his client’s interests first in an ethical decision making framework.

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Summary

• Ethics refers to the study of making good choices. Ethics encompasses a set of moral principles and rules of conduct that provide guidance for our behavior.
• Situational influences are external factors that may shape our behavior.
• Challenges to ethical behavior include being overconfident in our own morality, underestimating the effect of situational influences, and focusing on the immediate rather than long-term outcomes or consequences of a decision.
• In any given profession, the code of ethics publicly communicates the established principles and expected behavior of its members.
• Members of a profession use specialized knowledge and skills to serve others; they share and agree to adhere to a common code of ethics to serve others and advance the profession.
• A code of ethics helps foster public confidence that members of the profession will use their specialized skills and knowledge to serve their clients and others.
• A profession is an occupational group that has specific education, expert knowledge, and a framework of practice and behavior that underpins community trust, respect, and recognition.
• The requirement to uphold high ethical standards is one clear difference between professions and craft guilds or trade bodies.
• A primary goal of professions is to establish trust among clients and among society in general.
• Common characteristics of professions include normalization of practitioner behavior, service to society, client focus, high entry standards, a body of expert knowledge, encouragement and facilitation of continuing education, monitoring of professional conduct, collegiality, recognized overseeing bodies, and encouragement of member engagement.
• The investment management profession has become increasingly global, driven by the opening of capital markets, coordination of regulation across borders, and the emergence of technology.
• Investment management professionals are trusted to draw on a body of formal knowledge and apply that knowledge with care and judgement. In comparison to clients, investment professionals are also expected to have superior financial expertise, technical knowledge, and knowledge of the applicable laws and regulations.
• As a professional body, CFA Institute gathers knowledge from practicing investment professionals, conducts rigorous examinations, and ensures practitioner involvement in developing its codes and values.
• Investment management professionals are likely to encounter dilemmas, including those with ethical implications. Professionals should consider carefully how to determine the facts of the issue and assess the implications.
• High ethical standards always matter and are of particular importance in the investment management profession, which is based almost entirely on trust. Clients trust investment professionals to use their specialized skills and knowledge to serve clients and protect client assets. All stakeholders gain long-term benefits when investment professionals adhere to high ethical standards.
• Legal standards are often rule based. Ethical conduct goes beyond legal standards, balancing self-interest with the direct and indirect consequences of behaviour on others.
• A framework for ethical decision making can help people look at and evaluate a decision from different perspectives, enabling them to identify important issues, make wise decisions, and limit unintended consequences.