LM01 Ethics and Trust in the Investment Profession

Part 1

1. Introduction

To illustrate the importance of ethical behavior, the curriculum cites the example of an analyst’s action at a financial services firm. The research department at the firm is responsible for making investment recommendations to clients after sound analysis and valuation of companies. One of the analysts at the firm misrepresents facts in his report with the objective of pleasing the management of the subject company. He hoped this would lead to financial benefits for his employer and himself. Clients who acted on the recommendation incur heavy losses and spread a negative word on several online forums about the firm. This eventually affects the reputation of the firm, forcing it to downsize and many employees lose their job. This example illustrates how one member’s unethical actions have a spiraling effect on the firm and other employees for no fault of theirs.

The foundation of the investment management industry is trust and ethical behavior is central to creating that trust.

The top two attributes of an investment management firm are as follows:

• Has transparent and open business practices.
• Has ethical business practices.

Ethical behavior is not just about adhering to the law, rules, and regulations. It is about identifying potential conflicts and acting righteously in situations where there are no stated rules.

2. Ethics

The word ethics comes from the Greek word “ethos” meaning character, guiding beliefs, or ideals. There are several definitions of ethics all of which essentially convey the same meaning.

Ethics can be described as a set of moral principles and rules of conduct that provide guidance for our behavior. Examples of ethical principles include honesty, transparency, diligence, justice, being open about the costs involved in an investment, fairness, and respect for the rights of others.

Another definition of ethical conduct is behavior that balances one’s own interest with the direct and indirect consequences of the behavior on others.

Instructor’s Note:

The ‘others’ are often referred to as stakeholders, i.e. groups of people or individuals who are directly or indirectly impacted by our decisions. Examples of stakeholders in decisions made by investment industry professionals include colleagues, clients, employers, the communities in which we live and work, the investment profession, trade associations, regulators, and other financial market participants.

Specific communities formally define the rules for acceptable and forbidden behavior into a written set of principles called the code of conduct. Professional associations, universities and companies often adopt a code of ethics and expect their members to adhere to those rules, at the very least. The members may choose to display higher standards of behavior than what is stipulated in the code of ethics.

Some communities may also expand on their code of ethics and adopt explicit rules or standards that identify specific behaviors required of community members. These standards of conduct serve as a benchmark of the minimally acceptable behavior expected from members of a community.

3. Ethics and Professionalism

A profession is an occupational community having specialized knowledge and skills; which adheres to ethical behavior; and is subject to some combination of licensed status and technical standards. Examples of professions include doctors, lawyers, actuaries, accountants, architects, etc.

The number of professions has increased over time due to rising demand from clients and individuals. A profession is different from craft guilds and trade bodies in two ways, i.e. unlike trade bodies, members of professions are required to uphold high ethical standards and their mission is to serve society.

How Professions Establish Trust

The following characteristics help establish confidence and credibility in professionals and their organizations.

1. a. Professions normalize practitioner behavior by developing professional codes and standards.
2. b. Professions provide a service to society.
3. c. Professions are client focused: The major objective of codes and standards is to ensure that professions always act in the best interest of the client and exercise a reasonable level of care, skill, and diligence with regard providing them service.
4. d. Professions have high entry standards.
5. e. All members of a profession possess a body of expert knowledge.
6. f. Professions encourage and facilitate continuing education.
7. g. Professions monitor professional conduct to maintain integrity and reputation of an industry.
8. h. Professions are collegial and respect the rights, dignity, and autonomy of others.
9. i. Professions are recognized oversight bodies.
10. j. Professions encourage the engagement of members to develop expertise and ethics and to advance the profession.

Professions evolve over time as the requirements, technology, and standards change.

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