IFT Notes for Level I CFA® Program
R01 Ethics and Trust in the Investment Profession
4. Professionalism in Investment Management
Most countries require investment professionals to have some form of certification or licensing to practice. Due to regulatory coordination across borders and the emergence of technology, the investment management profession has become increasingly global.
Trust in Investment Management
Trust is the key in investment management and the trust is established by acting with care, due diligence, and judgment for clients. When market participants trust investment management professionals, it leads to efficient capital market and smooth functioning which in turn helps in the development of the economy.
CFA Institute as an Investment Management Professional Body
CFA Institute is the largest body for investment management professionals. The mission of CFA Institute is “to lead the investment profession globally, by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society.” CFA Institute candidates and charterholders are required to meet the highest standards among those established by CFA Institute, regulators, or the employer. The CFA Institute Code and Standards aims at aligning the interests of firms and clients.
CFA charterholders and CFA Program candidates are required to “adhere to the Code and Standards and to sign annually a statement attesting to that continued adherence”. Charterholders and candidates must “maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals”.
5. Challenges to Ethical Conduct
Some of the challenges to ethical conduct include the following:
Overestimating one’s morality: People believe they are more ethical than they actually are. This overconfidence in themselves can sometimes lead to faulty decision-making. It is often seen that emotions cloud rational thinking, prompting one to make decisions that may not be the most ethical choice.
Situational influences: These are external factors such as cultural, social, and environmental factors that influence one’s thinking, behavior, and decision-making. Some of the common situational influences are:
- Money and prestige: Both money and prestige push people to act in their own self-interests and take actions that are less ethical. The promise of a large financial bonus or a promotion, can impact people’s thinking ability and cause them to act in their own short-term interests and ignore the long-term consequences of their actions.
- Loyalty to employer, employee, and colleagues: Loyalty can have both positive and negative effects. For instance, some colleagues may encourage you to behave more ethically and enroll in the CFA Program to advance your career. On the other hand, colleagues who do not adhere to the Code and Standards may encourage you to simply act in accordance with the local law, even though it may fall short of ethical conduct.
- Compliance culture: A strong compliance policy is important for ethical decision-making; however, processes focused solely on compliance oversimplify decision-making and do not help the larger cause.
6. Ethical vs. Legal Standards
There is a grey area between what is legally accepted and what is ethical. Acting in accordance with the law and acting ethically are not necessarily the same. There are four possible outcomes for any action from a legal and ethical perspective:
- Not legal but ethical: For example, civil disobedience or protesting peacefully against an issue may not be legal, but it is ethical. Another example of an illegal but ethical act is that of whistleblowing. Whistleblowing is raising the curtain off an illegal or corrupt activity.
- Not legal and not ethical.
- Legal and ethical.
- Legal but not necessarily ethical: Some countries do not have laws that prohibit trading while in possession of material nonpublic information. While this act of trading is legal from the local country’s perspective, it is considered unethical by the CFA Institute and other investment professionals.
There are several reasons why laws are not sufficient to ensure ethical conduct among market participants, as discussed below:
- Laws and regulations are often created in response to existing market practices. A new law might address an existing ethical problem but create an opportunity for other unethical behavior in future.
- Laws can be interpreted differently. Market participants may choose to interpret the law to their advantage or delay compliance where there is no punitive action.
- Laws can vary across jurisdictions. This may encourage questionable practice to move to places that are less restrictive in nature.
Ethical conduct encourages us to:
- Go beyond what is legally required.
- Consider the impact on all stakeholders.
- Make good choices, even in the absence of clear laws and regulations.
7. Ethical Decision-Making Framework
Firms must strive to develop a strong ethical culture and encourage investment professionals to apply ethical decision-making skills every day; so much so that it becomes second nature. Working and operating in an environment that fosters integrity and accountability motivates its employees to do the right thing will go a long way in preventing unethical actions.
Setting up an ethical framework reinforces investment professionals to do the right thing. The ethical framework:
- Helps in evaluating a situation from multiple perspectives after considering the larger picture in such a way that it benefits stakeholders in the long term. Often, the impact of a decision or all aspects of a situation is not clear in the short term and decisions taken in haste may harm stakeholders unintentionally.
- Helps decision makers justify actions to a broader group of stakeholders.
The following ethical decision-making framework is presented in the curriculum.
- Identification phase: Identify all the relevant facts and distinguish between facts and personal opinion, judgements, and biases. This includes information one has and what one would like to have.
- Identify relevant facts such as details of the employer, information on an IPO or a deal, rules and regulations of the industry, etc.
- Identify the stakeholders such as employer, market participants, clients, supervisor, investors, family, etc.
- Identify relevant ethical principles for the situation. This may include loyalty to employer, clients’ interests taking precedence before everything else, and maintaining the confidentiality of information.
- Identify any potential conflicts of interest, or conflicts in your duties to employers/clients. Examples of potential conflict of interest include duties to one client versus other clients of the firm, financial rewards linked to the success of a deal versus duty to employer, and duty to supervisor versus the need to impress.
- Consideration phase: Seek guidance (preferably from someone outside the firm) to navigate through situational influences and personal biases that may affect decision-making.
- Examples of situational influences include how much fees the firm will earn from a deal, how much bonus or compensation one expects to receive because of working on an IPO/deal, or associating one’s self-worth to working on a prestigious account/deal.
- Examples of where one could seek guidance include the firm’s compliance department, peers, the CFA Institute Code and Standards, or a supervisor.
- Decide and act: Make a decision and act.
- Reflect: Once the decision is made, assess the decision to see if it had the desired outcome. If not, then analyze the reasons: were the stakeholders identified, was there any conflict of interest, were the ethical principles identified, did you seek guidance on how to deal with situational influences and personal behavioral biases?
Sometimes the information is not sufficient to make a decision in which case the process becomes iterative as you seek guidance to gather more relevant information.