Ethical Issues in the Financial Services Industry

Subodh Mayekar Finance A 2012097

Ethical Issues in the Financial Services Industry

Ethical Practices of Financial Services Organisations

1. What does an ethical financial services industry look like?

It should perhaps be said from the outset that there need not be anything intrinsically

unethical about the financial services industry. The industry provides essential services,

which are fundamental to support a modern economy and society, such as safeguarding

money and domestic lending. However, given the vital role that financial institutions

play, the moral hazards may be more acute and it is therefore logical that the industry

should be subject to higher ethical standards than other commercial sectors.

The question of what these ethical standards should be, how we judge them, and what we

are ultimately aiming for, is central to this debate. When an aspect of the law needs to be

determined, there is a mechanism for deciding what the outcome should be. But how

should ethics and its grey areas be determined? Should public opinion be the point of

reference? To do so could be a dangerous approach as public attitudes can change over

time – ethics is not a static concept. Whilst we may agree the norms at a high level, how

they are applied in practice will be hotly contested and bitterly fought. We can already

see this in the retail sector, where the line between ‘mis-selling’ and ‘mis-buying’

can be closely contested. What constitutes a ‘mis-sold’ product for one person, may be

seen as a fair transaction for another. Clients and shareholders can also push firms to

conclude transactions or pursue profits at the expense of ethics.

Looking forward to the end picture, the fundamental principles that any ethical financial

services industry should instil include:

1. Not pursuing profit at the expense of everything else including reputation.

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2. Behaviour that is marked by integrity, fair dealing and acting in the best interests

of clients.

3. Commitment to and delivery of technical excellence.

4. Prioritising good ethics over the instructions of clients where they conflict.

5. Looking beyond the question of what is legal – ie, being prepared not to act in a

certain way on the basis that it is unethical, even though it is legal.

6. Consistent application of positive ethical behaviour across the industry.

2 How should firms and regulators go about instilling an ethical culture?

Building ethical cultures in firms is as difficult to do as ethics are to define. This section

looks at the principles policy makers, regulators and firms should consider when building

an ethical framework, what the regulatory/legislative approach may be, and what can be

done at a practical level

What criteria should be kept in mind?

1. For both individuals and organisations, behaviour is shaped by the interaction of

internal and external factors. For individuals those internal factors are their own ethical

sense; for organisations it is their own structures, systems and culture. External factors in

both cases arise from the social context (or as sociologists would say) the “organisational

field” in which those individuals and organisations interact with one another.

2. As a result of this interaction, individuals’ personal ethical sense is socially

derived. It is shaped by immediate interpersonal interactions and by broader social factors

– in particular those of the organisations in which they work.

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3. With respect to an organisation’s ethical culture – the “ethical whole” is not the

sum of the parts, ie, is not the sum of the ethical cultures of those individuals within the

organisation. Organisations are comprised of individuals, but individuals alone cannot

necessarily withstand the structures, processes and the ethos of the organisation. As a

result, those who may be quite ethical in their lives outside work may behave unethically

in their corporate or professional lives.

4. Organisational structures and processes (notably remuneration structures) are

more likely to reinforce self-interested norms rather than those which are ‘other-

interested’.

5. Organisations are difficult to manage and run. The leaders of large organisations

face the same problem as regulators - thus management based regulation is not a solution

to the regulators’ problem. It simply displaces it. Senior managers, like regulators, face

problems of:

• seeing and knowing the activities which each is seeking to manage;

• governing at a distance: being able to affect a state of affairs or behaviour from a

distance, both spatially and temporally (in the future); and

• scale and scope: being able to do so over a significant number of activities which

in themselves may display significant variety.

As a result, internal pronouncements may be misunderstood, may be counteracted by other

practices, and simply may be ignored.

6. As a result of these factors:

• organisations risk sending contradictory signals about what behaviour is expected;

• individuals lower down the hierarchy may not trust senior management to behave

ethically themselves, either in relation to clients or internally.

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Some advocate the introduction of more legislation, for example a legal obligation for

firms and individuals to have regard to ethics, and/or more personal liability for unethical

behaviour. Indeed, two attempts were made (albeit unsuccessfully) to introduce fiduciary

obligations into the Financial Services Act 2012. Support for this approach may be drawn

from the criminalisation of insider dealing, which had the effect of changing perceptions

and conduct for the better. However, ethical duties are already in the regulatory1 and

legal realm and have been for nearly 25 years – they

were first articulated in regulatory rules in 1988, and have been present in equitable

duties for far longer. A better view may be that firms may have failed to understand,

implement and execute the existing principles, and that the regulator failed to properly

supervise, rather than there being a lack of regulation and law.

One important objection to the introduction of a legal requirement to act ethically, is that

it would not give guidance as to how a person should behave. Ethics vary according to

the issues at hand and are very much a matter of judgement. Arguably, ethics is simply

about how a person chooses to act because of who they are, and not because of what they

are required to do by law. The more one places a reliance on the law as a substitute for

taking responsible decisions, the more one devalues ethics as it then becomes a question

about what is required, rather than what is just the right thing to do.

3. Incentives and levers

A better angle would be to look at what drives the behaviour of individuals and firms and

to examine how those drivers can be leveraged to incentivise ethical action. Firms and

individuals are motivated to a large extent by the desire to:

• satisfy shareholders and clients;

• compete against industry peers; and

• maintain positive reputation and public image.

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A set of objective indicators of good and poor ethical behaviour could therefore act as

benchmarks for firms to compete against one another and could provide an impetus for

change. This would not require any significant costs or a change in law. Further, if clients

and shareholders make it clear that they expect firms to act ethically, this could also

provide a powerful incentive. Changing financial incentives and looking at remuneration

structures (currently a fashionable area) will also be a key tool. The FSA enforcement

process already publicly “names and shames” miscreants.

4. Self-regulation

There could also be a role for self-regulation in this area, with the creation of an industry

ethics group to collectively look at ethics across the industry.

5. Ethical scenario analysis and stress-testing

Ethical scenario analysis and stress-testing within organisations could also be a way for

regulators and firms to examine and address ethical weaknesses, in much the same way

as stress-testing for capital and resolution issues operates. The results could have

implications for regulatory strategy and serve to increase awareness within organisations.

In order to ensure consistency across the industry, we would need agreement on the most

ethical conduct and outcomes in the scenarios to be tested – a likely challenge given how

difficult it is to define ethics, but the approach could at least raise the profile of ethics

within firms and across the industry as a whole, and form part of its dialogue with

regulators.

6. Embed the regulator within firms?

One possibility is for the regulator to embed staff within organisations. The physical

presence of the regulator could help towards raising ethical standards where there are

issues. However, this suggestion requires considerable levels of resourcing from the P a g e 5 | 23


regulator and does not sit comfortably with intention for the FCA to have less routine

contact with firms. Whilst it might be possible to achieve these for a small group of

domestic banks providing deposit taking services, it is clearly not a practical solution for

the conduct regulator of upwards of 28,000 firms. There is also a risk of regulatory

capture, although this could presumably be managed.

7. Translating the principles into practice

How to translate the principles into practice will be challenging and vary from firm to

firm. This section raises some suggestions.

1. Cultural change and embodiment

For cultural change to occur within an organisation, it must be stimulated from the top of

the hierarchy, ‘mainstreamed’ down and embedded at each level. Responsibility for

cultural change cannot be delegated or siloed into compliance or risk divisions. The board

must understand the need for an ethics policy and be committed to monitoring its

effectiveness. Senior staff, including at board level, must be made an example of if their

behaviour falls short of ethical compliance.

rights terms, and that a host of safeguards would therefore need to apply which would

make enforcement difficult.

The FSA has also proposed (CP12/26) that the FCA and PRA should be able to make

statements of principle that cover not only the conduct of persons in relation to their

controlled functions, but in relation to any function that they carry on for the firm that

relates to a regulatory activity. It is not clear what standards would apply in relation to

those other functions.

Firms need to consider what role they want their internal (and for that matter their

external lawyers) to perform. Should they be advisers to business, or part of the

institution’s second line of defence? Should they act as gamers to help navigate the rules P a g e 6 | 23


to facilitate innovation, or rather as gatekeepers, to ensure compliance? Should their role

include advice on the ethical implications of decisions.

8. What should the role oflawyers be?

The FSA has recently turned its attention to the role of in-house lawyers in financial

institutions. If the disciplinary regime is extended to non-approved persons, and

principles are created for approved persons in respect of non-controlled functions, this

could have important implications for the position of in-house lawyers.

The value in lawyers is the ability to give impartial legal advice and challenge decisions -

to help promote a strong

compliance culture and to bring integrity and most importantly objectivity to the

business. There are however a number

of recent developments (in addition to the FSA’s proposed extension of the scope of the

approved persons regime) which present challenges to the way financial institutions

structure their legal function and the roles which they require their in-house lawyers to

perform.

In an SEC case, an administrative judge held that a general counsel who was aware of an

issue with a broker and was involved in addressing red flags, effectively became the

broker’s supervisor because his opinions were viewed as authoritative and his

recommendations were generally followed (on appeal, the case was dismissed because

the presiding Commissioners failed to reach a consensus). In Australia the High Court

ruled that a general counsel, who also fulfilled the role of company secretary, was to be

treated as an officer of the company in respect of all of his responsibilities, including

those of general counsel, so that the statutory duty of care he owed as an officer by virtue

of the national legislation therefore included the duty to take care and employ diligence to

protect the company from legal risk in relation to its legal obligations. Finally, recent

decisions of the European Court of Justice deny in-house lawyers legal privilege and the

right to represent their own firms in proceedings before European courts.

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9. Does the regulator need more powers or should it be using its current powers in a

different way?

The financial crisis has activated heated debate as to whether the regulator needs new

powers, enhanced powers, or whether it just needs to make greater use of its existing

powers. The ostensibly new product intervention powers were introduced into the

Financial Services Bill with much fanfare. However, what was perhaps overlooked was

that the FSA already had powers to make product interventions, and indeed had been

using them.

HM Treasury’s consultation on “Sanctions for the directors of failed banks” which

proposes that a director of a failed bank will be presumed unfit to hold further

appointment, also raises questions as to whether these new powers are really needed, or

whether they are being sought for political purposes. Arguably it is simply designed to

relieve the regulator of the evidential burden of proving fitness. The case for the

rebuttable presumption appears to be expedience – HM Treasury’s consultation suggests

that the presumption would make it easier for the FSA to refuse permission, than to have

to go through the current process. And, even more disconcertingly, this appears to be

driven by a wish simply tooverride the presumption of innocence which exists in English

(and EU) law. One for discussions/

As regards the introduction of criminal sanctions, even HM Treasury has acknowledged

both that there will be difficulties in bringing such criminal prosecutions (including the

time and expense) and most importantly, that it is already possible to bring a civil case.

Criminal sanctions do not feature in the proposals being put forward at the EU level in

the Liikanen report, which instead focuses on prohibitions and claw back of remuneration

as appropriate sanctions. Should that not be enough?

10. Is enforcement the right focus point?

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The FSA’s “credible deterrence” enforcement policy has in many ways been successful

in encouraging people to stop and think, albeit after the event. Perhaps criminal

prosecutions would make directors stop and think – although they may stop and think

about taking the role at all, rather than about taking a particular commercial decision.

However, is a policy of negative reinforcement the right way to drive long-term change

in attitude and behaviour across the industry? Whilst enforcement action may alter the

thinking and behaviour of those directly affected, it is unlikely to result in wholesale

ethical change. Even if people sit up and take notice of enforcement cases generally, in

practice, the risk of regulatory action may not ultimately influence a person’s behaviour,

particularly if they make decisions quickly and under pressure from external forces.

A degree of negative enforcement is of course necessary. However, this must be

accompanied by positive reinforcement of good behaviour, early intervention before

issues arise (as the proposed strategy for product intervention), and addressing incentives

which motivate unethical behaviour (including, but not limited to, financial incentives).

11. Conclusion

There is little doubt that ethical standards across the financial services industry have been

called into significant question across all areas, from the setting of benchmarks including

Libor, to sales to retail investors. There is also little doubt that embedding ethical cultures

within firms is a difficult task. Whilst regulation has a role to play in providing deterring

unethical conduct and promoting appropriate behaviour, ultimate responsibility has to lie

with firms themselves, including their shareholders. Firms need to focus on their

incentives and remuneration structures to ensure that compliant and ethical conduct is

rewarded, and provide clear and practical guidance on how it can be achieved.

Ethical practice in financial organisation

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Financial institutions -including banks of all sorts, credit agencies, private equity firms, pension

funds, insurance companies, and the like- have long been considered by most people to have no

other object in view than the creation of wealth. The performance of financial institutions is

therefore measured solely on the basis of their capacity to maximize financial assets, that is, it

has been measured with evaluation factors that review only their monetary bottom-line results.

How much return do they get on their investment decisions? How much are they able to

maximize the assets in their custody? How much profit can they derive from the loans and

credits they subscribe, from the bonds they float, from the equity they successfully issue on the

financial markets? Banks are judged by their ability to develop financial instruments such as

complex derivatives and sophisticated credit schemes that help connect the money of investors

with the companies in need of those financial resources in the best possible way. In pursuing

these ends, banks, and financial institutions in general, have long defended the confidentiality of

the information pertinent to their business, be it data about their clients, the sources and the

destinations of the economic resources they handle, their credit-giving policies and procedures,

and many more aspects of the banking profession that tend to be little transparent and not very

communicative about their way of doing business.

Financial institutions have become very complex and sophisticated in the way they operate. The

products and services they offer tend to be more and more complicated. The ways they invest

resources, the way they design, promote, and implement credit facilities, all become less evident

year after year, and the speed at which they evolve is ever accelerating. This complexity and

sophistication of the industry is in part a response to the shifting and ever-growing needs of the

banks’ clients. Companies in need of financing, and of financial services, tend to have more and

more complex businesses with complex needs and requirements of capital. Globalization also

plays an important role. Banks’ customers often do not have a localized headquarters but they

operate virtually everywhere in the world. Today, it could be argued, it is more difficult for

banks to know in detailwhere these customers operate and what exactly they do and how they

run their businesses. Moreover, clients change, merge, get acquired, move in and out of

businesses and markets much more rapidly than in the past. It is not only banks that change so

quickly, but their clients, and their clients’ needs also move and evolve at a higher speed.

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Unfortunately, governments, regulators, and other institutions simply cannot cope with this rate

of evolution in a satisfactory manner. Banks are moving too quickly for the reaction-time of

governments and other organizations. As a consequence, many important issues are being

overlooked by the institutions charged with directing our societies toward the common good.

Were one to give only a superficial consideration to the financial institutions and the implications

of their actions in the world, one could erroneously conclude that money is just another

commodity being traded. There is a danger that money will be treated as just another product that

makes things possible, as a simple means to accomplish an end. However, such an approach

bears the risk of becoming a highly inhumane approach when we look it in detail. Money is not

just another commodity being handled. Money, both in the form of credit and in the form of

investments, makes a huge impact on the world. Money is a means, not an end; but, it is a

powerful means to do things and therefore evil use of money can indeed create a considerably

negative impact on our world.

Where money comes from, and the destination it might have (that is, the sources from which it

proceeds and the places where it ends up being used), should not be treated as “just another

business transaction”. Money, in all of its forms, has implications and consequences. The things

we do with money, and the things we allow to be done with money, are not irrelevant from a

moral and an ethical perspective. Money implies actions, money allows things to happen, money

promotes and enacts changes. Money is a very important, if not the most important fuel for the

happenings in the world. Money helps, money builds, money buys, money creates and acquires,

but money can also destroy, pollute, kill, and support evil. Money should not be considered

simply in terms of the percentage points being generated as a return on an investment over a

period of time. Given that banks are the official intermediaries of money, we need to look at how

they handle money and what they do with it. By facilitating money to others, financial

institutions enact and empower them to do things with it. What clients end up doing with the

money they get from a bank, then, is then not irrelevant from an ethical viewpoint. This is all the

more obvious when we consider that the money banks handle, is indeed to a large extent,

investors’ money, not their own.

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To handle money as a commodity with no ethical implications and impact is to overlook critical

moral issues, issues that could in fact be financed, and thus, enacted, promoted, and effectively

created, by the investors’ money. In the end, whose money is the banks’ money? Who in fact

owns the money that financial institutions are investing and lending? In the end, it is the money

of individual investors. It is the money of pension funds, constituted in turn by the savings, the

taxes, the retirement plans of single individuals like you reading this paper.

Given the fact that money can be used in a wrong way -and it frequently does get used in such a

way- and considering that money is eventually funded to a very large extent by individual

investors, we should ask: is it still morally acceptable that financial institutions invest and lend

money indiscriminately, watching only the bottom-line? Should bank secrecy and confidentiality

never be held to answer for the moral and ethical implications that money can have in our world?

Is it acceptable that governments and regulators lag behind financial institutions’ questionable

way of doing businesses because “the markets can’t wait”? Can we rightly ignore where our

money is being used, what it is financing, where it is being invested, as long as it generates a

good return in percentage terms? Can banks really justify their arms-length approach to their

investments and financing consequences and impacts on our world as far as they generate more

money?

How banks use money is not irrelevant from a moral and ethical perspective. Crime, pollution,

corruption, violation of human rights, threats to human life, totalitarian regimes, and all sorts of

wrong-doing need and use money every year. Financial institutions play a key role in the supply

and movement of money. In this essay we intend to draw your attention to the key role the

banking industry plays in that supply chain of money. Moreover, we will call your attention to

the fact that it is your money, which can play a key role in that supply chain and that is not

morally or ethically avoidable anymore to investigate and to actively question how banks are

using that supply chain to channel your money, with financial practices that can be fueling wrong

doing across the world. Let us clarify that, whenever investors’ money is channeled to evil-

investments by financial institutions, it is the bank who is guilty of this wrong-doing and not the

individual investor, unless of course, the individual investor were aware of the wrong-doing (and

if he were just as easily able to invest his money elsewhere, and if he were a significant enough

investor to influence the company or fund in question). What we attempt here is to call the P a g e 12 | 23


investors’ attention to the importance of the potential damage that their money could do when

invested in the wrong destinations.

What are our main concerns?

We have several concerns regarding financial institutions and how they use money. Banks can

channel economic resources in different ways that make money result in some form of evil-

doing. The two main ways in which banks can do this are (a) by lending money to others, that is,

by issuing credit facilities to their clients, these being customers corporations, governments,

individuals, etc., and (b) by actively and directly investing money, that is, owning shares, be it in

the name of others or for themselves, in companies, projects, or countries, that conduct different

forms of wrong-doing. Owning shares of companies that could be conducting wrong-doing is, of

course, not exclusive to financial institutions; however, the large sums of funds that banks have

available to invest make these investments particularly relevant when we analyze ethical issues

facing banks.

When banks lend money to others, the bank may not be doing wrong by itself; it is these other

entities which might be engaged in wrong-doing. However, this does not excuse banks from their

moral responsibility. Money enables and promotes actions, and in this sense, banks lending

money to evil-doers are facilitating their activities. It is not valid to argue that a bank is only in

the business of financing and lending and that therefore they carry no ethical responsibility in the

wrong-doing. Banks effectively enact, enable, and promote the realization of actions with their

lending of financial resources. In the lines below we will discuss how banks and financial

institutions have been known to effectively fuel wrong-doing through the issuance of credit

facilities to clients in questionable businesses, and through other actions that range from actively

holding shares of companies with questionable practices, to speculation and other questionable

matters.

Ethical issues in the financial services industry affect everyone, because even if you don’t work

in the field, you’re a consumer of the services. The Post Chair supports research and studies of

the social responsibilities and ethical challenges facing the financial services industry.

1 .- Usurious practices.P a g e 13 | 23


Banking is a business concerned with protecting and growing people’s money. As such, one of

its principal purposes is to generate wealth, in the form of financial returns for its shareholders.

As in any industry, it is understandable and acceptable that banks try their best to maximize their

investments and therefore, it is logical that banks charge interest rates on the loans and financing

activities they offer to their clients. However, banks that charge excessive interest rates, abusive

commissions, or ultra-profitable credit charges that go beyond reasonable standards for taking an

extra benefit from a specific situation in detriment to their customers, are guilty of usury. Usury

may be defined as demanding significantly more money back from customers than is just and

fair. Financial institutions consistently engaged in usury are accordingly a subject of our concern.

While we do not necessarily endorse bureaucratic regulations which may be excessively

burdensome and counter-productive, we do expect banks to act morally with respect to lending

practices within their organizations which are potentially usurious. We are concerned that banks

are frequently charging excessive rates and imposing unfair advantages for themselves upon

customers. We thus expect banks to take care to implement policies that prevent wrong-doing in

the form of usury and similar sorts of abusive practices.

Financial institutions are also guilty of some forms of usury when they encourage their

customers, especially individuals, to go into excessive debt by taking irresponsible credit at too

high interest rates. Some credit customers, specially those located in low-credit penetration

communities are frequently being subjected to excessive marketing and pressure to drive them

into credit at advantageous interest rates that go beyond what is customary in the industry.

2.- Speculative banking.

The assets a bank lends and invest should be handled responsibly, even moreover so, when we

consider that the bank is investing and lending money that belongs to other people, i.e., the

individual and institutional investors whose money they manage. Engaging in excessively

speculative investments and irresponsible credit lending practices is morally unacceptable, and in

many cases, not even good business. We believe bankers and financial professionals should take

a responsible approach in all investment and lending operations with its customers’ money. Even

in the case of high-risk, high-return type of clients, a bank is the ultimate entity making the

investment decisions for the investors, and practices of speculatively investing heavily in too-

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risky securities just for the sake of short-term returns should be considered cautiously, especially

given the massive loss of wealth that we have witnessed during the current financial crisis. The

point is that there is always an ethical component involved in these too-risky investments that is

being ignored. This crisis has made evident that investing in financial securities of questionable

value (such as derivatives without the adequate collateral, sub-prime mortgages, irresponsible

adjustable-rate-mortgages, and other investments that do not undergo the serious due-diligence

required) have frequently resulted in clients’ wealth destruction.

The situation of over-speculative, over-risky banking gets especially complicated from a moral

perspective when we consider that clients seldom receive the necessary, detailed information to

let them know what kind of investments their bankers are undertaking with their money. Another

aspect of concern regarding speculative banking, which has also been evidenced in this crisis, is

the fact that many financial institutions have been involved in speculative investments resulting

in enormous losses for their customers while their executives continue to receive compensation

packages and bonuses in the millions of dollars. While we understand that the banking

profession has traditionally generated a lot of wealth for its executives, their excessive bonuses

become an ethical concern when their clients’ wealth has been destroyed precisely because of

these forms of speculative investment practices.

3.- Financing arms manufacturing and trade.

Many banks are actively financing the military industry around the world. While we recognize

the moral acceptability of a country taking care to defend its population, and thus investing in

arms and weapons, we are concerned with excesses and human rights violations involved in this

activity. We are specifically referring to indiscriminately destructive, overly-damaging weapons

and their manufacturers and distributors. These usually fall in the category of so-called “cluster

munitions” which are highly-destructive weapons which not only destroy an enemy’s military

target, but quite frequently kill thousands of innocent civilian victims.

Why are cluster munitions so harmful? Cluster-munitions are designed to destroy large areas,

thus their use often results in the destruction of civilian settlements, killing innocent people. On

top of this, cluster-munitions weapons cause damage after the military attack as they contain

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many explosive components that did not act at the moment of the attack but remain active there,

and explode afterwards. A potential mine field is created wherever cluster-munitions have been

used and their destructive potential can last for years hidden under the ground. This information

has been corroborated several times by different organizations around the world, and yet

regulation does not actively prevent the manufacturing of these weapons, and of course,

regulation doesn’t prevent financial institutions from either investing or lending money to these

companies.

It is believed that a large percentage of cluster-munitions victims are civilians. Several studies

support these statistics, and yet, manufacturing companies have no difficulties in securing credit

from banks. More than 60 financial institutions have been identified to be involved in financing

these companies, and it has become such a lucrative business that between the period of 2004-

2007 more than € 10 billion euro have been channeled to the six major cluster-munitions

manufacturers which are: GenCopr (USA), Lockheed Martin (USA), Raytheon (USA), Textron

(USA), Thales (France), and EADS (The Netherlands). All these companies openly produce

cluster-munitions arms that have been used in several conflicts such as in Iraq (by the US army),

in Lebanon (by the Israeli army), and many other places like the former Yugoslavia or Sudan.

Some weapon-manufacturing companies have obtained credit facilities of very considerable sizes

from well-kwon financial institutions. We are talking about credits in the billions of dollars. We

cannot pretend that Banks did not know the purpose of the financing facilities they were

arranging.

Even worse is the fact that banks now also own shares in these cluster-munitions manufacturers.

Several reputed financial institutions own shares in companies like GenCorp, Lockheed Martin,

Textron, and Raytheon, which add up to double-digit equity positions in those companies.

Owning shares in a company known to manufacture such weapons has ethical and moral

implications. Money invested in securities enables companies to do things with it, and therefore,

these investments have corresponding ethical repercussions. To own such a considerable amount

of equity in a company means the owner is actually involved and interested in the progress of

that company and in the performance of the products it manufactures and sells.

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4.- Financing and supporting totalitarian regimes.

Banks frequently give loans to companies operating in countries governed by totalitarian regimes

such as Burma, North Korea, or Sudan. Those companies in turn use the money to enter those

markets. Some of these countries are plagued with corrupt government authorities that frequently

require them to give substantial bribes to allow them to operate in those nations. By financing

these companies, banks are allowing money to flow into these totalitarian regimes which have no

respect for human rights and who use this money to strengthen their positions in their respective

countries. The fundamental problem is not that a company be present in a country with a

repressive regime, but that its business there is somehow complicit in propping up or

perpetuating the repressive regime.

5.- Financing of companies with little or no commitment to social responsibility.

The banking industry usually grants credit facilities to companies, and helps in raising capital in

the financial markets, to companies operating with no socially-responsible agendas, or with little

commitment to one. We are referring, amongst others, to companies operating in third-world

countries that allow child-labor, overwhelming pollution of the environment, black economies,

and so forth. We have observed companies that have little respect for their workers and which

have consistently violated labor laws (mainly in developing countries) having no problem

securing credits from well-known banks. So far, banks have not been interested in questioning

clients about their human-rights or social-impact agendas. Banks tend to look at the risk-return

ratio of their investment as the sole basis for granting the credit.

Some banks are financing companies, for instance in the infrastructure industry, that operate in a

highly utilitarian way in some countries. Some infrastructure developers, for example, that build

water dams around the world have been accused of impacting the communities in which they

operate by forcing the displacement of people from their home communities to build the dams

wherever it is more economically convenient for them to build them, regardless of the social

impact this might have. Moreover, these companies have been accused of manipulating potable

water sources in poor countries by linking itself to corrupt governments like the Burma Junta or

the regime in Sudan. Banks lending money to companies like these facilitate their operations,

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and thus, often their wrong-doing. Making money available to companies operating in this

manner fuels their wrong-doing. Funds channeled to these types of companies can easily end up

in the hands of those totalitarian regimes. These funds are not only the bank’s money, but more

importantly, the individual investor’s money.

6.- Ecological Impact.

We should expect banks to start looking more in detail at the potential ecological damage that

their clients could be generating when receiving financing from them. Companies known to be

involved in activities that result in substantial environmental damage through the extraction of

fossil fuels for instance; companies polluting the seas through the release of toxic chemicals;

companies that manufacture products which persist in the environment and are linked to health

concerns; and any other company damaging the world should not receive financing so easily as

they do today from banks and financial institutions. While we recognize that avoidance of all

possible environmental damage is often very expensive and hard to achieve, we believe that the

efforts should be at least seriously pursued. We expect companies to actively search for a balance

between their activities, their production processes, their use of natural and human resources and

the respect for the environment.

The same goes for companies involved in unsustainable harvest of natural resources, including

fishing, timber, and other natural resources should also be severely questioned by banks when

asked for financing. Moreover, banks, pension funds and in general, every investor, should be

very cautious when it comes to buying or holding securities (be it bonds, shares, etc.) in all these

kinds of companies. By investing in these environmentally unfriendly companies, financial

institutions give them access to important sums of capital, which in turn, results in larger

environmental damage.

The same rationale goes for companies involved in aggressive, unnecessary animal testing of

cosmetics and household products or ingredients. We recognize testing is an important step of

many manufacturing processes; it is abusive, unnecessary, excessive, testing which we want to

avoid. Intensive farming methods, blood sports, trade in the furs of endangered species, and other

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animal unfriendly businesses are also of our concern when they make use of animals for

unnecessarily violent and superficial entertainment activities.

7.- Financing, donations, and sponsorships contrary to the good of the family.

As financial institutions handle huge amounts of capital, the impact of their donations and

sponsorships can be substantial and the money they channel through donations can have

important impact on society. In this respect, we are particularly concerned with banks giving

active support to organizations that advocate against the institution of family and against family-

values. As we are convinced that the family is the basis for any healthy society, we are interested

in seeing banks staying away from initiatives that somehow can affect the integrity of family or

attack family values in any way. These activities could include granting financial support to

causes that actively promote activism against family values. While we acknowledge that there

are other points of view regarding the value of families and their role in society, we prefer to

keep our investments, and recommendations for our clients’ investments away from companies

promoting non-family friendly causes and activism. We prefer not to generate our wealth from

investing in companies that opt for financing, promoting, and supporting entities and

organizations that do not share our view on family and family values as the cornerstones of

society, peace and harmony.

8.- Involvement in social enterprise.

The banking industry plays a key role in the development of the markets in which it operates. By

lending and raising money, a bank can effectively help develop a community, but further than

that, a bank is expected to get actively involved in supporting the development of that

community in which it operates. More and more banks and financial institutions are praised

when they support organizations such as cooperatives or credit unions, or get involved in

financing of community initiatives. Given the fact that a bank benefits directly from the

economic resources of a community, we would be concerned when a bank openly neglects to

help those communities in which it conducts business.

Is a better banking industry possible?

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The answer is absolutely YES. Better, ethically-responsible, respectful banking and financing

industries are not only possible, but also highly desirable, and they are already starting to

emerge. Some banks, mainly small institutions in developed countries have realized the

importance of being ethical beyond their internal Code of Values, that is, beyond paper and

beyond what is strictly within its operations. Individual investors will play a key role in putting

pressure on banks and regulators to let them know that banking practices cannot go on as

independent of ethics any longer. The relevance of what banks do with the people’s resources is

material.

A number of organizations around the world are starting to pay attention to how money is being

used and to the moral implications it has. Some important institutional investors are becoming

much more concerned with the handling of their investments. Institutions like the Government

Pension Fund of Norway, the so called, “Folketryfondet”, the world’s largest single holder of

equity securities, has been implementing strict ethical criteria to handle their investments. Some

bank-industry watch-dogs like Bank Secrets Organization or Netwerk Vlaanderen of Belgium,

have started to lobby regulators to implement stronger policies for the banking industry.

Eiris Research of Ireland has been advising individual and institutional investors to make them

conscious of the moral relevance of taking care where their money is been invested. Some banks

like Triodos Bank of the UK are starting to offer their clients alternative ways to invest their

money considering the ethical and the financial impact of their investments. Some government

agencies like the UK Treasury have started to work on designing better regulation for the

banking industry. The world is changing and investors both individual and institutional are

starting to pay attention to the ethical implications of their money. A world where investments

and loans are made on the pure basis of financial return is not any more acceptable and we at

Fidelis International Institute are here to make our contribution.

1) Self-interest sometimes morphs into greed and selfishness, which is unchecked self-interest at

the expense of someone else. This greed becomes a kind of accumulation fever. “If you

accumulate for the sake of accumulation, accumulation becomes the end, and if accumulation is

the end, there’s no place to stop,” he said. The focus shifts from the long-term to the short-term,

with a big emphasis on profit maximization.

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For example, swaps (where two communication companies agree to exchange the right to use

excess bandwidth on their networks) fall into this category. Each company recognizes the

income generated in the quarter earned and defers the expenses through capitalizing them as an

asset and logging the cost as a recognized expense over time, resulting in an inflated bottom line.

This is what happened at Qwest during the first three quarters of 2001, when the company was

selling $870 million of capacity, while at the same time buying $868 million of capacity. These

swaps appeared to be round-trip transactions, which served no purpose other than to inflate

Qwest’s revenues, Duska said.

“Companies were making money out of their finance department—not from selling products, not

from doing what the company did, not from fulfilling the company’s mission, but from playing

around with its asset mix,” he said.

2) Some people suffer from stunted moral development: “I think this happens in three areas: the

failure to be taught, the failure to look beyond one’s own perspective, and the lack of proper

mentoring,” Duska said.

Business schools, he said, too often reduce everything to an economic entity. “They do this by

saying the fundamental purpose of a business is to make money, maximize profit, or the really

jazzy words ‘maximize shareholder value,’ or something like that. And it never gets questioned,”

he said. “Now if the fundamental purpose never gets questioned, the ethics never get questioned,

because the fundamental purpose of something gives you the reason for its existence. It tells you

whether you're doing it well or not. It's the ultimate ethical question: What's your purpose?”

3) Some people equate moral behavior with legal behavior,disregarding the fact that even though

an action may not be illegal, it still may not be moral. “You ought to remember that the reason

for all laws is that the moral agreement begins to break down, and the way to get other people in

line is to legislate so that we can stipulate punishments,” Duska said. Yet some people contend

that the only requirement is to obey the law. They tend to ignore the spirit of the law in only

following the letter of the law.

For example, IRS regulations repeatedly single out actions with “no legitimate business purpose”

(like swaps.) “If you are doing things with no legitimate business purpose in order to avoid

taxation, what are you doing? You’re violating the spirit, are you not? You’re staying within the

letter, but there’s no purpose there except to get you around the law,” he said.

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4) Professional duty can conflict with company demands. For example, a faulty reward system

can induce unethical behavior. “A purely self-interested agent would choose that course of action

which contains the highest returns to himself or herself,” he said.

For example, consider the misguided practice of selling indexed annuities to the elderly. If a

company is paying a high commission for that product, say 15 percent, versus a lower

commission for a more appropriate product, say 3 percent, a salesperson may disregard the needs

of the client and/or assume that the company supports this product and its applicability by its

willingness to pay five fold the compensation. “Sooner or later, people are going to give in to

that temptation. The purely self-interested agent is just responding to the reward system that is in

place,” Duska said. “You need to take a look at what you are rewarding.” In general,

organizations get exactly what they reward. They just don’t realize that their rewards structures

are encouraging dysfunctional or counter-productive behavior or turn a blind eye to the outcome

5) Individual responsibility can wither under the demands of the client. Sometimes the push to

act unethically comes from the client. How many people expect their accountants to pad their

expenses where possible? How many clients expect their insurance agents to falsify their

applications or claims? “That’s the temptation—you like your client, you’ve gotten to know your

client, you really want to help your client out—that’s just another conflicting loyalty,” Duska

said.

Mitchell concluded the presentation with several suggestions for improvements in the industry to

encourage more ethical behavior. “My experience [in the financial services industry] is that

people who do business are, for the most part, highly ethical people trying to do the right thing

most of the time. Most of them are trying to help their clients achieve their financial objectives,”

he said. “But how could this be better, because clearly, even if I’m right, there are still a lot of

issues and problems in the business?”

First of all, consumers need to be better informed. “It is your responsibility to take control of

your own financial security,” he said, which doesn’t mean you need to know everything about

the product you are buying in advance, but “you should read enough to know what some of the

right questions are to ask.” Ask those insightful questions of an advisor whom you know, trust,

and who has the proper credentials, if applicable.

Other suggestions included:

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incentive compensation better aligned with customers’ interests, rather than agents’

more industry trade associations supporting ethics initiatives

the Center for Ethics in Financial Services growing in influence and impact

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Documents

Ethical Issues in the Financial Services Industry