Evaluating Ethics in Finance and Investing



Ethics can be defined as the study of what constitutes right or wrong behavior. It is the branch of philosophy that focuses on morality and the way in which moral principles are derived or the way in which a given set of moral principles applies to one's conduct in daily life. Different people face different kind of ethical questions in their day to life and in their business life. Ethics usually assumes people are rational and make free choices. We can also say that it has got certain rules to follow in our interactions and our actions that affect others. There can be many ethical questions that arrive in our daily life or in business life like fairness, justness, rightness or wrongness.

Both ethics in finance and investing are part of business and business ethics focuses on what constitutes right or wrong behavior in the business world and on how moral and ethical principles are applied by business persons to situations that arise in their daily activities in the workplace. Ethics that are faced in personal life is much more different and complex in business life.

Social Influences on Ethics

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When evaluating professional decisions and behavior in the finance and investment industry, high standards of ethics and blatant violations of ethical conventions are difficult to explain solely in terms of individual traits and personality. Situational factors may lead to considerable differences in the ethical standards of behavior of a single individual in different social situations-a fact that has been revealed time and again by media reports. Thus, a true understanding of the psychology of ethics in the world of finance and investment requires awareness of how people interact and influence each other ethically. 1

1. See: Thomas Oberlechner Webster University Vienna "The Psychology of Ethics in the Finance and Investment Industry" Research Foundation of CFA Institute from http://www.cfapubs.org/doi/pdf/10.2470/rf.v2007.n2.4697

Ethics in Finance

Ethics of finance is concerned not solely with the ethical problems of individuals in a specific occupation or profession but also problems in financial markets and financial institutions. Financial ethics is about more than trust 2. If we analyze how financial system works, it is easy to see that it is easy for financial fraud and deceit. As almost all the people in United States have a 401K which is invested in financial market through different financial companies. All the people investing their money come from different walk of life and have limited knowledge in financial market. The only way public can believe in an investing firm to invest in their lifetime saving is by trust. This trust is built over the years by these firms by following correct ethical procedure (by the firm and its staffs).

2. See: John Raymond Boatright (1999) Ethics in Finance. Blackwell Publishing

Ethics in the Investment Profession

Ethical practices by the investment professional benefit all market participants and stakeholders and lead to increased investor confidence in global capital markets. Ethical practices instill a public trust in the fairness of markets, allowing them to function efficiently. In short, we can say that good ethics is a fundamental requirement to the investment profession. 3

3. See: Ethical and Professional Standards and Quantitative Methods. Level I 2008. Pearson Custom Publishing

The Code of Ethics for Finance and Investment

Act with integrity, competence, diligence, respect and in an ethical manner with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets.

Place the integrity of the investment profession and the interests of clients above their 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 themselves and the profession.

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

Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals. 4

4. See:

Ethical and Professional Standards and Quantitative Methods. Level I 2008. Pearson Custom Publishing

The Psychology of Ethics in the Finance and Investment Industry

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Financial and investment professionals are particularly vulnerable to ethical wrongdoing. But what makes some blatantly violate ethical standards and even break the law while others behave highly ethically?

This monograph sheds light on the psychology behind ethical and unethical behavior. It explores fascinating psychological insights into the characteristics of unethical personalities and the role of unconscious attitudes in unethical decisions.

It examines how group processes, leadership, and organizational reward systems can turn otherwise ethical persons into unethical persons, and it demonstrates how rationalization tactics, moral disengagement, and impression management are used to psychologically justify or conceal unethical actions.5

5. See: http://www.asiaing.com/the-psychology-of-ethics-in-the-finance-and-investment-industry.html

Approaches to Ethics

When people talk and write about ethics in the finance and investment industry, they approach the topic in variety of ways and address different realms of ethics. Usually, their dealing with ethics takes one of three main directions: (1) what investment professionals should do, (2) what they actually do, or (3) how finance and investment professionals can be helped to get from what they actually do to what they should do.

Normative Ethics

What should finance and investment professionals do? As the name implies, normative ethics aims at establishing norms and guidelines for professionals regarding how they should behave. This approach to ethics is inherent in, for example, the ethical theories of moral philosophy, theology, and definitions of professional norms, standards, and acceptable behavior for a professional field. Thus, a normative approach to ethics in finance and investments defines what is ethical in this profession. It tells practitioners how investment professionals should act to be ethical, which behavior should be considered ethical, and which behavior should not.

Descriptive Ethics

What do investment professionals actually do? Descriptive ethics aims at describing not how people should behave but how they actually do behave. And descriptive ethics attempts to explain and predict the unethical behavior of people in real-life situations (O'Fallon and Butterfield 2005). Psychological research conducted in controlled laboratory studies and real world settings of professional decision makers offers a systematic and comprehensive basis for descriptive ethics in finance and investing. Only this psychological and descriptive approach allows us to understand when and why people and organizations in the investment industry engage in ethical behavior and when and why they do not.

Prescriptive Ethics

How can finance and investment professionals be helped to get from what they actually do to what they should do? Based on descriptive insights about the factors influencing actual ethical decision making, the Prescriptive approach to ethics aims at helping people and organizations toward ethical decision making by giving advice about how to create environments that foster ethical decisions and how to improve the ethical component of decisions. The two main questions addressed by prescriptive ethics are the following: How can we create organizations that foster ethical behavior? How can we train professionals to readily perceive the ethical dimensions of their own behavior and to act ethically? Thus, prescriptive ethics suggests tools that assist people in making the prescribed decisions. 4

4 See: Thomas Oberlechner Webster University Vienna "The Psychology of Ethics in the Finance and Investment Industry" Research Foundation of CFA Institute from http://www.cfapubs.org/doi/pdf/10.2470/rf.v2007.n2.4697

Ethics and Investment Performance in Emerging Markets

One of the major reasons why most people in the 'developed' world are still skeptical about emerging markets is the issue of ethics. There have been many strong debates about whether doing business or investing in emerging markets should be any different from the more developed market. For most people investing for the long term - ethics, governance, social and environmental issues have become more relevant. Even the challenge posed by climate change is not as serious in emerging markets as it is presently in the developed market. China is one of the largest consumers of energy but even the Chinese government says about 70% (700 million) of its population still live in abject poverty and in rural areas, this is despite the rapid growth of the economy.

What these suggest is that by all means China, India and other serious emerging markets will continue to pursue growth and development and probably at the expense of the environment. Is that ethical? The G8 countries will also continue to mount pressures on these countries to cut carbon emission

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How do emerging markets become developed markets if they cannot use the same source of energy that the developed world has used to get to where they are today? Yes there are lots of researches going on to develop energy-efficient fuels but how long will that take so as not to hamper continuous growth? These are some of the questions long term investors are asking before they invest their hard-earned money in these markets. If the more developed economy can force the emerging markets to 'suspend development till we find energy efficient fuels', would it still make sense to invest or do business in these markets? 5

5 See: http://www.midas-funds.com/2007/08/ethics-and-investment-performance-in.html

Ethical Issues in Finance Industry

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 public seems to have the perception that the financial services sector is more unethical than other areas of business.

There are many situations where you act without considering if it is ethical or not. For example, you would not think much of someone claiming personal traveling expenses as official traveling expenses to save tax. This was a clear example, where ethical and unethical conduct could be clearly demarcated. However, in practice, the line between ethical and unethical is quite thin. So, how do companies ensure ethical behavior?

Most large companies have a code of ethics-a set of general guidelines to encourage employees to behave ethically and responsibly. However, a code of ethics might do more harm than good especially if it lays stringent do's and don'ts. This might give the employees a false notion that anything if it is not specifically forbidden would be acceptable. In addition to the company specific codes of ethics, companies and professionals are also bound by ethical codes of conducts of numerous professional organizations and institutions.

Business and professions are resorting to more unethical conduct in today's age compared to previous decades. However, experts attribute this to new business situations and the resulting problems that are more complex. For example, companies are under tremendous pressure to show good results on a quarterly basis and this might lead to a situation where slight manipulations of financial numbers might seem justifiable.

Experts also agree that ethical behavior is governed more by the individual rather than the environment. There have been cases where whistleblowers have exposed unethical behavior or violations of the company's code of ethics and brought huge organizations down to their knees. But, these are rare instances. Research shows that whistleblowers are often sacked from their jobs and end in worse conditions than if they had kept quite. Such cases of violations of code of ethics breeds cynicism. It would appear that having no code is better than a written code of ethics. A company code of ethics is useful only when the company's actions are consistent with it. Only then can it be followed consistently within the company. 6

6 See: http://www.moneyinstructor.com/doc/ethicalfinance.asp


Our society is interworking of people built in the pillar of trust. This trust is based on molarity and ethical behavior. For financial market not only Ethics is the pillar, it is also a ladder for success. Lose that trust and the firm or individual is going downhill. So financial firms should not only keep code of ethics in paper but also promote self-regulation. For financial market Ethical integrity is paramount and clients always come first.