What are Ethics?

• Ethics: The moral standards by which people judge behavior. Ethics can be summarized by the “golden rule” – “Do unto others, as you would have them do unto you.”

Business Ethics: The moral values that guide the way corporations or other businesses make decisions. Ethics are the structured examination of how institutions and individuals should behave in the world of commerce.

Example: A portfolio manager must give the same consideration to the portfolio of family members as the portfolio of small, individual investors.

Why are Ethics Important?It is important to have a set of ethical guidelines in every profession. They act as a set of values that service professionals can operate by.

Ethical business practices give customers confidence that their interests and assets are being protected.

Professionals, by virtue of being in a specialized industry, generally are experts in a particular field. When the knowledge is used in exploitative ways, ethics are not present.

The industry’s reputation is untarnished and clients can put trust in the industry when ethics are publicly known and displayed.

Ethics vs. Law

There is a difference between ethics and law. Something can be legal, but unethical. In the financial industry, it is important for professionals to adhere to the highest ethical and legal standards.

Example: Business Week addressed a real life example of how the law and ethics can disagree. In the article, TV producers of a reality show allowed a woman who is an alcoholic to drive while intoxicated. Under the law, the TV producers are not responsible for the woman and are treated as witnesses to the crime and not held liable for any accidents that occur. However, it is argued that the producers have an ethical responsibility to stop the woman to ensure innocent people are not harmed.

Fiduciary Responsibility

Financial service professionals have the responsibility to put the interests of their clients and customers above their own interests. This means that professionals must work for their clients when making investment decisions. They have to act objectively to ensure the best advice is given. The word fiduciary comes from the Latin word meaning “trust.” It is paramount for financial professionals to maintain their clients’ trust and act in their best interest.

Example: Financial professionals need to base their recommendations on customers’ individual needs, investment timeline, age, and other information to choose investments that are best suited for their situation. Financial professionals should NOT base their recommendations on products that have the highest commission associated with the sale.

Types of EthicsKantian Ethics

This type of ethics is derived from philosopher Immanuel Kant.

Under Kant’s view, an action is only right if no one is hurt or negatively affected in the decision process.

Every individual must be taken into account during the decision-making process.

Utilitarian Ethics Makes decisions that

create the best solutions for the most people.

Another way to distinguish this type of ethics is asking if “the ends justify the means.”

An action is “right” if more people will benefit from it than will not benefit from it.

Corporate Responsibility

The ethical standards set forth by an individual firm. Generally, a firm will put in place a proxy statement outlining the ethical standards it will adhere to. These standards usually include making decisions with the best interest of their clients, shareholders, and the community in mind. Corporate Responsibility also creates standards for ethical practices between employees (fair hiring, non-harassment, etc.).

Why are Ethical Business Practices Hard to Maintain in the Financial Industry?

Generally, a financial representative’s livelihood

relies on his/her productivity or sales.

Incentives and bonuses are given to employees based

on production. Thus, employees are more

tempted to make decisions that will increase their

commissions and bonuses.

Case Studies: Ethics in Finance

An energy and commodities company that filed for bankruptcy in 2001 after releasing fraudulent accounting

statements to investors from the mid 1990s to 2000s.

Former President, Jeffery Skilling, was charged with multiple felonies and is currently serving 24 years in prison. He was

also fined $24 million.

Chief Financial Officer, Andrew Fastow, served six years in prison for his involvement.

ENRON: The Smartest Guys in the Room is a 2005 documentary depicting the scandal.

ENRON

The Smartest Guys in the Room Trailer: http://www.youtube.com/watch?v=1dNZaKLjYbc

Case Studies: Ethics in Finance

Bernard Madoff Operator of the largest Ponzi scheme in US history.

– Ponzi Scheme: A fraudulent investment operation where investors’ money is used to pay other investors. In essence, money is shuffled around while the runner of the Ponzi scheme greatly exaggerates the gains from the operation.

Madoff fabricated gains to his investors of approximately$65 billion when his investors had actually lost a total of $18 billion.

Sentenced to 150 years in prison and forced to forfeit over $17 billion in March 2009.

It is often described as a pyramid scheme.

Ponzi Scheme

Case StudiesMarc Dreier

Unraveled Trailer: http://www.youtube.com/watch?v=r7oRSYgx9QU

A prominent lawyer who was convicted in May

2009 and sentenced to 20 years for running a

Ponzi scheme from 2004-2008.

Dreier swindled $400 million from hedge funds and investors by selling

$700 million of fictitious/worthless

financial instruments.

Dreier’s story is told in the 2011 documentary,

Unraveled.

Careers in Financial Markets

Financial Institutions: Organizations that include banks, trusts, and insurance companies.

Financial institutions are the entities that allow individuals,

companies, governments, etc. to make deposits, exchange currency,

take out loans, and invest in different financial instruments.

Careers in Financial Markets

1. Commercial Banks

Loan Officers: Work with a variety of clients ranging from large

businesses to individuals. Establish relationships with people trying to

borrow money.

Credit Risk Analysts: Work to price risk in order to

make decisions regarding clients’ eligibility to

receive loans and what rate (cost of finance) these

clients will pay.

Examples of Commercial Banks are Bank of America, JP Morgan Chase and Wells Fargo.

Careers in Financial Markets

Retail Branch Management:

Responsible for all functions of a retail

bank branch including managing employees, building relationships

with customers and the community and

approving loans.

Operations Support Management: Back-

office operations that support the bank’s business of deposit taking and lending.

2. Investment Banks: Financial Institutions that are major purchasers of financial instruments. Investment banks are involved in both the “buy” and “sell” side transactions in financial instruments (example: Goldman Sachs).

Careers in Financial Markets

• Salesperson: Sells financial instruments to investors (typically institutions).

Trader: Buys and sells financial instruments for their own portfolio. Their goal is to buy “low” (at an inexpensive price)

and sell “high” (at a more expensive price) making a “spread” - or profit.

Research Analyst: Studies financial markets. Writes research reports used by buy-side institutions to make investment

decisions.

Operations Support Management: Settles trades – the buying and selling of financial instruments.

Careers in Financial Markets

3. Other Institutional Investors: Consist of both “buy side” and “sell side” institutions.

Careers in Financial Markets

“Buy Side” Institutions: These institutions buy financial instruments to assemble

portfolios to achieve certain objectives.

Hedge Funds: A fund comprised of a group of different investments and strategies controlled by a manager. Investors in a Hedge Fund must be qualified that is, their net worth be

at least $1 million not including their primary residence.

Private Equity: A firm that manages private investments for institutions and high net worth individuals. They generally buy companies, improve their efficiency, and then sell (exit) those companies for a profit. (Example: BlackRock).

Mutual Funds: A fund financed by a pool of capital from many different investors. The mutual fund is run by a manager who makes investment decisions based on the goals set forth in the prospectus. (Example: Fidelity Mutual Funds).

Careers in Financial Markets

Pension Funds: Invest in many different financial instruments in

order to generate enough capital to provide retirement benefits to its members. (Example: TIAA CREF).

Insurance Companies: A company that collects payments and, in return, protects the insured against adverse events (i.e. accident, death, property destruction). The company invests

payments in different financial instruments in order to generate capital growth to pay the

insured if claims are made. (Example: Prudential Insurance Co.).

Careers in Financial Markets

What are Some Main Differences between Mutual Funds and Hedge Funds?

A mutual fund is safer for investors because, under law, the managers

cannot take very risky positions. Also, only a small amount of investor capital

is required to invest in mutual funds and the funds are generally very large.

A hedge fund is less regulated. Managers are permitted to take risky positions and a great deal of capital is

needed to invest in hedge funds.

“Sell Side” Institutions

Brokerage Firms (Salespeople): A firm that sells financial instruments and completes the trades for buyers and sellers. They match sellers then act as the intermediary for the transaction. They generate profits by collecting commission from trading (example: Charles Schwab).

Corporate Finance Associates: Advise companies, municipalities and governments with mergers and acquisitions, investment decisions and growth strategies. Assist companies in determining optimal financing strategies.

Certified Financial Planner: Individuals who are responsible for the analysis and management of a client’s overall financial/investment portfolio. They analyze each customer's financial situation, timeline for retirement, financial goals over the long term, and then make recommendations accordingly. Investment advisors are paid a flat fee or percentage fee based on the amount of assets they manage.

Financial Planner

The Treasurer’s Office works with Corporate Finance Associates to determine growth and financing strategies. It manages the corporation’s investment portfolio.

Treasurer

4. Treasurer’s Office of a corporation.

5. Financial Service Regulation and Compliance: Many different positions exist at different regulatory “watchdogs” of the financial industry.

Regulation and Compliance

Examples: Federal Reserve, Securities & Exchange Commission (SEC), Internal Revenue Service (IRS), Financial Industry Regulatory Authority (FINRA), etc.

Requirements for these positions often include a Bachelor Degree in Business, Math or Economics. However, many firms appreciate academic diversity so an interest in the economy and the markets might enable one without the specific educational background to start a career in the financial industry.

Careers in Financial Markets