Ethics in Finance Lecture Notes
Lecture 1 – Introduction
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Ethics are defined as moral principles that govern a person’s behaviour or the conducting of an activity.
There are many approaches to ethics including but not limited to: Utilitarian, Deontological, Virtue and Pragmatic.
External factors that contribute to a Business’ commitment to Ethics are:
-Legislation
-Industry Regulators & Associations: APRA, ASIC, AFMA and ABA
-Competitors
-Investors & Shareholders
-Clients
-Indices and Surveys
-Economic trends & world events
-Society & Community Standards
Internal factors that impact ethical governance in a Business are:
-Organisation type
-Management Structure
-Leadership & role-modelling
-Environmental, Social & Governance approach
-Reporting
-Values & Code of Conduct
-Remuneration policies and practices
-Risk management: audit & compliance
-Training and performance management
-Office environment
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The Individual
Our moral compass, our own values & principles generally the results of influencing factors such as upbringing, family, culture and education etc, should be
aligned to our duties as an employee to provide a basis for ethical behaviour. This includes fiduciary, confidentiality, obeying the law, following regulators
and reporting to superiors.
Supporting employees to do the right thing
-Policies & Practices
-Colleagues
-Manager or Boss
-HR
-Compliance
-Ethics Office
-Your own education and study
-Your own moral compass
-Ethical framework of the organisation and society
-Lawyers and Regulators
Despite this level of support, the individual in a workplace will still face ethical dilemmas.
Challenges to individual integrity are
-Being asked to do something that isn’t right
-Being tempted to do something that isn’t right
-Feeling a personal conflict about a deal or transaction you are involved in.
-Witnessing bad behaviour
These dilemmas are made worse when the individual is:
-Time poor
-Under Pressure
-Unsupported
-Unsupervised
-Stressed
-Fatigued
-Isolated M
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Factors that influence individuals are:
-Experience
-Team
-Personal Opinion
-Time
-Theories, tools and technique
-Environment
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Workplaces
Modern Workplaces have created an environment that is
-Flexible
-Considers work life balance
-Provides opportunities to train and mentor other people
However a downside is created:
-These workplaces are rather competitive
-Provide a lack of security
-Create a constant feeling of work as your list of work related task do not finish when you physically leave the office
Over time ethical work cultures have eroded due to
-Moral Muteness: people may couch their decisions under economic or time related reasons to hide them being unethical or immoral.
-Limited view of stakeholders: When unethical choices are justified as being in the best interest of particular stakeholders (mainly shareholders) others are
left out of the question.
-Unthinking custom and practice: Outdated work practices deemed as unethical.
-People faking it: Lack of integrity
Self deception theory
1. Tribalism: belief that the company is always right
2. Legalism: The inability to imagine moral obligations beyond the law
3. Moral Relativism: Excusing unethical practices by viewing business as a game and oneself as a “role” or “player”
4. Scientism: Elevation of science, management science to a position of unquestioned authority.
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When does a business problem involve ethics?
When you are made to reflect on what is a correct or incorrect response
When you are forced to consider where your obligations and duties lie
When it raises a problem for someone else
Common Workplace Dilemmas
-Misuse of information
-Morality of business deals
-Self Advancement
-Exploiting loopholes
-Being instructed to do something that isn’t right
-Witnessing bad behaviour
Ethical dilemmas & culture
Different ways of doing business
Bribes and facilitation payments
Dealing with superiors
Alcohol at work related events
Role of women in the workplace
Staff entertainment
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Dealing with Dilemmas
Test of integrity:
-Put yourself in the other person’s shoes
-How would I feel if my actions were to become public
Good decision making:
1. What’s the story? Facts, Assumptions, Understandings, Non Negotiables, Extenuating circumstances.
2. Voices in the conversation. Identify the significant stakeholders, major values and principles related to the issue.
3. Frame The Dilemma: A choice between the options available
4. Generate Options: Brainstorm the options
5. Provisional Position: Final decision.
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6. Identify weaknesses in your position: Can you modify your position to reduce/eliminate weaknesses
7. Final Check: ‘The Golden Rule’ – putting yourself in other person’s shoes. Would your mentor/s agree to your decision? Sunlight test: what if your
decision was made public?
Business Case for being Ethical
-Improves trust
-Reduces “integrity” and operational risks
-Avoiding legal and financial penalties for breaches
-Constructing then external reputation
-High ranking in surveys and indices
-Recruit and retain top quality staff
-Creates a sustainable business
Lecture 2 – Moral Philosophies
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Moral Philosophies
-Teleology
-Deontology
-Virtue Ethics
-Relativist Perspective
Welfare, Rights & Justice
Ethical Position 1 – Teleology
The teleological school of thought states that an action is only morally acceptable if and only if it produces a desired result for the greater good of the
greatest number of people. It namely branches off into 2 perspectives:
1. Egoism  right/acceptable behaviour entirely in terms of self interest consequences for the individual
2. Utilitarianism  concern with consequences for the greater good of the greatest number of people, concerning with the maximisation of utility.
“The evolution of utilitarianism”
Bentham’s View “Principle which approves/disapproves of an action, according to its impact to augment/diminish the happiness of a party whose interest is
pursued. Creates a focus on hedonistic calculus = quantitative aggregation of pleasure/pain.
Mill’s View “Actions are right in proportion as they tend to promote happiness, wrong, as they tend to produce the reverse of happiness” Asserts that
pleasure should be quality weighed.
Classical View An action is only right if it produces the greatest balance of pleasure over pain for everyone.
Act Utilitarianism “An action is only right if it produces the greatest balance of pleasure/pain for everyone” i.e. Merger & Acquisition.
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Rule Utilitarianism “An action is right if it conforms to a set of values and the general acceptance of which would produce the greatest balance of
pleasure/pain for everyone.”
Four elements to Utilitarianism
Consequentialism – only ends matter
Hedonism – only pleasure is good
Maximalism – greatest amount of pleasure is best
Universalism – consider the aggregate
Economic argument of market efficiency states that markets will lead to Pareto optimality – but this may not necessarily be a fair/just outcome. There are
also many problems associated with this argument is that there are one too many assumptions such assuming perfectly competitive markets.
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Equality, Liberty and Virtue
Ethical Position 2 – Deontology
Deontological Ethics
Deontology as a school of thought focuses on the rights of the individual and on the “intentions” underlying the behaviour, not its
consequences  There are things we should not do, regardless of the utility derived from them  Respect for others (and ourselves) as
rational people is a 2nd formation of Kant  Rationality gives people a greater moral value than anything else  This puts greater stress on
welfare of every person than utilitarianism.
Kantian Ethics
Foundations underpinning decisions  Restores reason to moral life (things we ought not to do by virtue of being rational). He suggests a
binding moral law that is irrespective of consequences/utilitarianism. Kantian theory is quite simple “Act on rules that you would be willing to
see everyone else follow”.
Rawl’s Egalitarianism
Questions of justice arise when free and equal persons attempt to advance their own interests conflicting with other pursuing their self-
interests. Social justice enables persons with conflicting ends to interact in mutually beneficial ways. We should aim to achieve the greatest
benefit of the least advantaged.
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Rawl’s Principle of Difference states to achieve the greatest benefit of the least advantaged.
Rawl’s Equal Opportunity Principle the offices positions open to all under conditions of fair equality of opportunity.
Libertarianism
Hayek emphasises individual liberty, property rights and limited government – strong arguments favouring a market system.
Nozick’s entitlement theory – A distribution is just if everyone is entitled to the holdings they possess
• Principle of just transfer
• Principle of just original acquisition
Supports a market system with absolute minimum of government intervention.
Common criticisms of libertarian theory are
-Some rights (minimum welfare) are at least as important as property rights.
-Not all restrictions of liberty are due to interference by the state.
-The principles are hardly realistic.
Ethical Position 3 – Virtue Ethics
Virtue can be considered as an acquired character trait that manifests itself in habitual action; a state of character; an admirable trait
Virtues are means to happiness, character traits that lead to a good life Morality is not something we think about but do out of habit.
Virtue Ethics are defined by current societal definitions’
Vice Of Deficiency – Virtue As the Mean – Vice of Excess
“Behaviour when confronted by danger on a significant personal challenge”
These are intrinsic and habitual responses taken by us.
Can be applied in the business sense as getting along with others, having self-respect & being part of something to admire.
Business related character traits need to be added to familiar personal character traits.
Considers relationships in business as opposed to basic teleology and deontology.
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Ethical Position 4 – Relativist
According to the relativist school of thought, ethical behaviour is defined by experiences of the individual and the group. Personal growth in
emotion, human relationships and character formation promotes personal moral development which is becoming aware of one’s ethical
potential.
“Communitarianism” states that people are social and can only achieve their moral potential by being part of a growing and developing
community. Thus, different communities are expected to develop their own different set of values and moral principles.
“Self Interest” states that each person should seek their own happiness through a productive independent life in which their own rational
judgement is their only guide.
Implementation of theories
• Trigger levels – of such importance that an action can be chosen because it meets this criterion alone
• Veto levels – of such importance that an action can be rejected regardless of all other criteria
• Reject level – criterion that should not be considered
Lecture 3 – Internal Business Ethics
1. Loyalty and integrity
Employees are often expected to maintain the highest levels of honesty and integrity, both inside and outside working hours, maintain confidentiality as well
as devote their best efforts to the business of the firm. Most organisations have a statement of mission and value, codes of ethics and codes of conduct.
These formal statements reflect senior management’s organisational values, rules and policies, but may not reflect shareholder values.

It is a key role of management to make sure that the integrity and loyalty expectations of the employees do not conflict with one another.

Sacrifice is about making the right trade-off between loyalty and integrity. Integrity demands the sacrifice of things (money, status, power) for its
maintenance. Loyalty is the sacrificing of integrity to obtain things (money, status, power) for oneself or for some other body such as an organisation.

2. Whistleblowing –
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exposing an employer’s wrongdoing to outsiders, such as the media or government, regulatory authorities.
Formal definition 
“The voluntary release of non-public information, as a moral protest, by a (former) member of an organisation outside the normal channels of
communication to an appropriate audience about illegal and/or immoral conduct in the organisation or conduct that is opposed in some significant way to
public interest. This is an example of upholding utmost integrity in one’s environment.”
Principled resignations
Some people resigned as a matter of principle when they saw or experienced ethical wrongs at work e.g. harassment and bullying, employment
discrimination, in order to maintain their personal integrity. But they did not blow the whistle internally or externally; some went public after their
resignation.
Conditions for justifiable whistle-blowing
• Is the situation of sufficient moral importance to justify whistleblowing? A product or policy of an organisation needs to possess the potential to do harm
to some members of society.
• Do you have all the facts and have you properly understood their significance?
Documentary evidence should be in the possession of the prospective whistle-blower to be presented to external authorities.
• Have all internal channels and steps short of whistleblowing been exhausted? First report facts to immediate manager, if to no avail, take the matter to a
more senior manager, exhausting all available internal channels in the process.
• What is the best way to blow the whistle? Once you go public, to whom and how much information should be revealed? Should it be revealed
anonymously? Need clear plan of action.
• What is my responsibility in view of my role in the organisation? The whistle-blower must be acting in good faith, without malice or vindictiveness.
• What are the chances of success? The prospective whistle-blower must believe that the necessary changes will be implemented as a result of their
whistle-blowing act.

Good whistleblowing policy
• Effectively communicated statement of responsibility
• Clearly defined reporting procedure
• Well-trained personnel to receive and investigate reports
• Commitment to take appropriate action
• Guarantee against retaliation
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Pros and cons of a whistleblowing policy
Pros
• Early identification of problems
• Taking corrective action before problems are made public
• Signally moral fortitude to stakeholders
• Creating an ethical corporate climate
Cons
• Potentially create an environment of mistrust and intimidation
• Policy existence may lead to moral hazard
• Risk of false accusations causing irreparable harm in trust and public image

3. Trade secrets
Companies have rights with respect to trade secrets and other IP (patents, copyrights, trademarks). Employees have an obligation to maintain
confidentiality during their employment, but also have a right to change employment.
Arguments for trade secret protection
• Property
Trade secrets are legally regarded as intellectual property belonging to the owner(/creator). Patents, copyrights, trademarks are ‘tangible’ property granting
exclusive use and right to sell/license, obviating the need for secrecy.
• Right to fair competition
Businesses need to internalise the benefits they provide to employees, otherwise there is the free-rider problem. Therefore, employees usually sign
noncompetition agreements. So employees have legal obligations to act in the company’s interests. However, such arguments should not impose undue
hardship on the employee’s ability to gain employment.
• Obligation of employee confidentiality
Employees are ‘agents’ of the employer and bound by the duty to preserve the confidentiality of information. Confidentiality agreements are open to similar
restriction on employee mobility and career prospects.

Competitor intelligence gathering
Systematic collection and analysis of competitor intelligence is an accepted (necessary) practice in the corporate world. A company that is “careless” in
allowing its trade secrets to become public, has no right to prevent competitors from using it –but they do have a right to prevent the use by others if it was
obtained illegally.
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• Theft and receipt of unsolicited information – violation of property rights (receiving stolen property)
• Misrepresentation – false pretences (e.g. posing as a customer is dishonest)
• Improper influence – bribery, breach of trust, promising employment
• Covert surveillance – violation of privacy

4. Conflict of interest
Conflict of interest occurs when a personal interest comes into conflict with an obligation to serve the interests of another.

Relevant distinctions in conflict of interest
• Actual/potential conflicts Act vs possibility
• Personal/impersonal conflicts Representing two clients may be an impersonal conflict • Individual/organisational conflicts
Kinds of conflict of interest
• Biased judgment – e.g. purchasing agents accepting gifts from suppliers
• Direct competition – with employer
• Misuse of position – powers or opportunities not available otherwise
• Violation of confidentiality – precludes the use of information acquired in confidence
Managing conflict of interest
• Objectivity – serves to avoid being biased by an interest that might interfere with ability to serve another
• Avoidance – may be difficult to anticipate or identify; or may be entirely unavoidable (an organization may seek alignment of interests)
• Disclosure – (transparency) allowing the party potentially harmed to disengage or at least be on their guard
• Competition – provides a strong incentive to avoid conflicts of interest
• Rules/Policies – stipulating priorities; avoiding acquiring adverse interests, etc.
• Independent judgment – independent advisory board
• Structural Change – where conflicts lead to compartmentalising
Lecture 4 – Corporate Social Responsibility
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Corporate Social Responsibility refers to the responsibility of an organisation for the impacts of its decisions and activities on society and the environment
through transparent and ethical behaviour that:
-Contributes to sustainable development, including the health and the welfare of society.
-Takes into account the expectations of stakeholders.
-Is in compliance with applicable law and consistent with international norms of behaviour.
-Is integrated throughout the organisation and practised in its relationships.
Arguments for and against CSR
The classical view for CSR is that the prime responsibility of an organisation is to maximise profits. Considers CSR to be rather secondary or a bottom
priority.
Adam Smith’s view for CSR stated that it is the responsibility of ourselves in society to establish a framework of law such that an individual pursuing his own
interest is led by an invisible hand to promote an end which was no part of his intention. We develop our legal system and other framework in such a way
that firms, who are rationally profit seekers are sought to act in ways that incorporate corporate social responsibility. This is in direct contrast to Freeman’s
view that corporations should aim to satisfy and create value for all stakeholders to thrive and succeed.
The economic objection asserts that CSR distorts the allocation of capital and results in inefficient markets in which profit maximisation does not occur and
thus societal benefit does not either.
The political objection asserts that senior executives should not act as unpaid tax collectors by engaging activities that vary from the core of their business.
The philosophical objection is that corporations are legal fictions/entities and not real people and thus cannot possess real responsibilities to look after
societal welfare.
The Socio-economic view is that the responsibility of firms goes beyond that of profit maximisation and towards protecting and improving society.
Carroll’s position is that there are 4 fundamentals to CSR which are Economic, Legal, Ethical and Philanthropic & can be linked to positive developments such
as environment assessment and stakeholder management.
Benefits for the Business:
CSR improves trust, employee engagement, reputation, ahead of anticipated reporting requirements and creates a sustainable business.
In Practice
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Key CSR Issues
-Promoting gender equality
-Mitigating climate change
-Combatting bribery, money laundering and corruption
Other issues:
-Indirect responsibility in social and environmental issues via customers
-Employees
-Financial inclusion
Key Components
-Commitment  A formal commitment from CEO and Board
-Formalised  Reference to CSR in mission/vision statements, annual report, websites etc
-Performance Criteria  Performance of business and employees judged according to CSR principles
-Reporting  Reporting mechanisms in place to monitor impact and developments
-Engagement  Forums for collaboration and coordination across business and stakeholders
Methods & Tools
CSR Instruments include
1. Code of conduct
2. Management systems
3. Forums of stakeholder engagement and cooperation
4. Non-financial accounting and reporting
Frameworks and Tools
-Global reporting initiative (GRI)
-Corporate Responsibility Index (CRI)
-Dow Jones Sustainability (in cooperation with SAM)
Dimensions
-Compliance with legislation
-Contribution to the political process
-Meeting of non-mandatory legislation
-Activities related to beyond compliance of suppliers
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Best Practice
-Broad Scope  taking into consideration the environment and ethics
-Linked to Business monitoring decisions and outcomes interlinking business activity with CSR
-Reporting Lines  reporting CSR to CEO and the Board of Directors
-Independent Advice  Independent CSR advisors on board and committee can help potentially bring in new & innovative ways to implement CSR in line
with Business Activity to benefit all stakeholders
-Integrated Reporting  Annual Reports
-Public Voice  A voice in business and public debate on CSR/ESG issues
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Corporate Governance
Corporate Governance encompasses the entirety of processes, policies, law and institutions involved in the direction, administration and control of a
business. It also includes the relationship between the various stakeholders of the business and the business’ objective.
Corporate Accountability encompasses financial reporting (accounting, auditing and ethical issues), the role of the board of directors (independence) and
criminal law (prosecution of management and directors).
Property Rights
Although individuals exchange assets/property for shares, they jointly own the common enterprise. Natural Rights refer to mixing one’s labour with nature
creates a relationship.
Social Institutions
Corporation is also a public enterprise serving a larger social goal (with a public interest), linking the individual to a larger culture.
Contractual Theory
Firms can be seen as a network of contracts (actual and implicit) which specifies roles. Firms exist as less costly alternatives to market transactions.
Stakeholder Theory (1963)
Those groups without whose support the organisation would cease to exist.
Freeman (1980s)
For businesses to be successful they have to create value for all stakeholders. Stakeholders cannot be seen in isolation. This is in direct contrast to
Friedman’s view which asserts that corporations only exist to maximise profits.
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In Practice
ASX Corporate Governance Principles and Recommendations:
1. Lay Solid Foundations for management and oversight
2. Structure the Board to add value
3. Promote ethical and responsible decision making
4. Safeguard integrity in financial reporting
5. Make timely and balanced disclosure
6. Respect the right of shareholders
7. Recognise and manage risk
8. Remunerate fairly and responsibly
Internal Controls
Monitoring by the Board of Directors
Internal control procedures and internal auditors
Balance (separation) of power
Remuneration and incentives
External Controls
Competition
Government Regulations
Managerial labour market
Media pressure and societal trends
Economic and Market Conditions
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Internal Business Ethics
Types of International Organisations:
Multinational Corporations (MNC) refer to corporations that have their facilities and assets in at least one country other than their home country.
Multi-domestic companies refer to subsidiaries in different countries that operate the entire value chain including purchasing, production, marketing, sales
activities and R&D. Integration between activities across subsidiaries and country borders are limited.
Characteristics of International Organisations
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-View business in a world market
-Products and services make relatively little concessions to the particularities of different national markets
-Willing to move capital and operations to favourable locations
Challenges for MNCs
• Corporations should find a good balance to settle their business in, where they can take into account both the global norms (absolutism) but also
respecting local rules and practices (relativism).
• Understand culture – understanding the country’s customs and how they do business.
• Accepting alternative ways of doing business
• Dealing with less developed legal and regulatory systems
• Managing workforces of expats and locals – Being able to create a harmonious workplace culture between the local Australian culture and Asian culture in
these countries is important for Telstra to establish to ensure expats and locals get along well.
• Engagement with the local community; impossible to work in isolation; need to understand local community
Criticisms of MNCs have focused on
• Market power (buying power) • Dubious moral conscience (maybe not understanding a particular culture) • Encourages cultural homogenisation – rather
than respecting and letting cultures flourish, MNCs bring in a certain degree of standardisation • Unfairly benefit from weak institutional and legal
frameworks (e.g. exploiting lower wages)
Potential benefits of MNCs
• Lift standards of corporate governance (bring well-established practices to a new location)
• Facilitate economic development
• Provide employment
• Create positive cross-cultural relations
• Allow for dialogue on shared social issues
Case study – bribery
Bribery – money or favour offered or given to a person in a position of trust to influence that person's views or conduct.
Suggested causes:
- Cultural acceptance
- Seen as the price of doing business in a competitive environment
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- Lack of monitoring and training
- Political involvement in decision-making
- To gain entrance in new markets

Factors considered in assessing a case
• Legality
• Cultural context
• Advantage gained
• Impact on other parties
Lecture 5 – Integrity of Financial Markets
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Equitable and Efficient Markets
Formal markets are extensively regulated to ensure equitable and efficient trading occurs.
Efficiency (prices signalling the true value of assets) can only occur if market participants have confidence in being treated equitably.
As financial markets have been developed and created, efficient price discovery has been significantly enhanced.
Fair Markets
Fairness is about preventing losses per say, but offering a fair game to all market players – regulation exists to protect investors directly and the general
public indirectly.
 Fraud & Misrepresentation refer to wilful misrepresentation of a material fact that causes harm to a person who reasonable relies on the
misrepresentation. In finance the information presented is often hard to verify as it is forward looking.
 Mandatory disclosure regulations refer to any material non-public information needs to be revealed instantly before any trading commences.
Equal Information aims to level the playing field – play by the same rules with the same tools.
But, in reality markets are characterized by asymmetric information. This means that not everyone has access to the same level of information. Inequality of
information is only unfair if an advantage is illegitimately obtained or created or when it’s use violates obligations to others.
Aim to reduces information asymmetry to enhance efficiency and fairness
Equal Bargaining Power – Inequalities may arise due to unequal information but also due to:
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 Resources
 Processing Ability (Traders that deal with financial markets routinely vs moms & dads)
 Vulnerabilities
The law will only intervene if exploitation of the power is unconscionable.
Efficient Pricing
The price should reflect all available information (in fair and orderly markets)
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Material Information and Insider Trading
Material non-public information: Information is material, if it’s disclosure would likely have an impact on the price of a security or if reasonable (rational)
investors would want to know the information before making an investment decision.
There must be:
 Specificity of Information
 Significant difference from public information
 Reliability of the information
Information is “non-public” until it has been disseminated or made available to the marketplace in general. There must be a reasonable expect that people
have received the information. Issues of selective disclosure arises when a corporate insider provides material information to analysts in briefings or
conference calls before the information is released to the public.
In the US, Regulation Full Disclosure has banned Selective Disclosure even to analysts. The theories on the next page evaluate whether this is all good.
Mosaic Theory
Financial analysts gather/interpret large quantities of information. They may use significant conclusions derived from the analysis as the basis for
recommendations even if these conclusions would have been material inside information had they been communicated directly by an insider. The analyst is
free to act on this Mosaic of information.
Compliance and Firewalls
Prevents misuse of material non-public information, can be done through:
 Disclosure policy to ensure that information is disseminated equitably
 Issue press release prior to analyst conference calls.
 Create appropriate information barriers (firewalls)
 Internal communication within the company through a legal clearance arena
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 Review of employee trading (watch/restricted/rumour lists)
 Heightened review of restriction of proprietary trading while in possession of non-public information.
Empirical Evidence
Do company insiders exploit their knowledge>
1. Evidence of leakage of useful information to some traders before public announcement – dividend (earnings) increase announcements are often
preceded a few days by a share price increase!
2. SEC summary of insider trading measure performance of insiders – when insider buyers exceed insiders sellers the stock subsequently tends to
perform well (poor).
Dual Trading
Dual traders trade on their own accounts and process orders from their retail customers
Dual trading is endemic to many asset markets
There is a sense that dual trading must harm retail traders as there is a one sided information flow.
But it may also enhance efficiency by creating liquidity.
Frontrunning
A process whereby an investment position is taken on non-public information about an impending transaction in the same or related asset.
Examples include:
 Analysts/Brokers who buy up shares of a company just before the brokerage is about to recommend the stock as a strong buy; or
 A broker who buys a parcel of shares in a stock just before his/her brokerage places to buy a large block of shares.
Tailgating
Occurs when a broker or advisor buys or sells a security for a client/s and then immediately makes the same transaction on his or her own account.
This is not illegal like front running but it is not looked upon favourably because the broker is most likely placing a trade for his/her own account based on
client information.
Thereby the broker piggybacks on inside information.
Why insider trading is wrong?
Property Argument  Misappropriation of the corporation’s competitively valuable information (trade secrets/confidentiality).
BUT not all information fits that description.
AND the corporation may want to reward its employees with insider information (stock option plans).
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Fairness Argument  Other traders are barred access to valuable information (to make rational choices).
Some say insider trading makes markets MORE efficient through informative trades (but they will care at a cost to disadvantaged traders-they may withdraw
from the market and subsequently make markets less efficient).
Proponents of Insider Trading?
 A legitimate form of compensation for corporate employees, permitting lower salaries that, in turn, benefits shareholders;
 An absence of statutory definition of insider trading, may lead to unfairly penalizing traders whose conduct comes close to the line.
 Strict insider trading regulation may have a chilling effect on the work of security analysts, prohibiting “sensible dialogue” between company officials
and analysts;
 A victimless offense and enforcing insider trading prohibitions is simply not cost effective.
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Market Manipulation
Manifests itself in two ways:
I. Transactions that deceive market participants by distorting the price-setting mechanism
transactions that artificially distort prices or volume to give the impression of activity or price movement ▪
securing a controlling, dominant position in a financial instrument to exploit and manipulate the price of a related derivative and/or the ▪
underlying asset
II. Dissemination of false or misleading information
Spreading false rumours ▪
Manipulating prices
Pump-and-dump
A scheme that attempts to boost the price of a stock through recommendations based on false, misleading or greatly exaggerated statements.
Perpetrators, with an already established position in the stock, sell the positions after the hype has led to a higher share price.
Traditionally, this type of scheme was done through cold calling, but since the advent of the internet this illegal practice has become more prevalent.
Short-and-distort
Where investors who short sell a stock and then spread unsubstantiated rumours and other kinds of unverified bad news in an attempt to drive down the
equity’s price and realise a profit. This is much easier in periods of corporate distress and investor uncertainty.

Manipulating volumes
Ramping
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Actions designed to artificially raise the market price of listed securities by giving the impression of voluminous trading.
Churning
When a trader places both buy and sell orders at about the same price. The increase in activity is intended to attract additional investors and increase the
price. Can also mean excessive trading by a broker in a client's account largely to generate commissions.
Wash trade
Selling and repurchasing the same or substantially the same security for the purpose of generating activity and increasing the price
Corner the market
Requires purchasing enough of a particular asset, to allow the price of that asset to subsequently be manipulated by withholding supply of the asset and
then dictate its price.
Squeezing the market
Requires cornering of the underlying asset market and then utilizing that control to extract profits from shorts who have to deliver the underlying asset.
Lecture 6 – Duties to Employees and Clients
M1
Loyalty, Prudence & Care
Loyalty – Act of the benefit of the clients and put their interest before the employer or their own interests.
Prudence – Exercise prudent judgement.
Care – Reasonable Care.
Position and Test
Trust is crucial in the client/manager relationship. The test is to apply the same care one would if it was their own money.
Loyalty
 Avoid Conflict
 Avoid compensation incentives that can result in acting in a manner that is not in the client’s best interest.
 Preserve confidentiality of information
 Refuse gifts or offers
Prudence
 Exercise caution and discretion
 Balance risk and return
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Care
 Avoiding harm to clients
Ethical Risk – Churning
Definition – Executing trades to generate commission such as twisting and overtrading.
Churning is normally identified when
 The Broker controls the Account
 Trading is excessive for the character of the account
 Broker acted with an intent that varied from the clients’ risk and return profile
Ethical Risk – Commissions
Commissions are defined as payments for services and products calculated on percentage basis of the sale price and is a rather common way to
reward salesmen.
 Evident in Banking & Finance in the form of mortgage brokers, financial planning, superannuation and trading positions.
An alternative in the form of “fee for service” payment has been commonly suggested.
Developments
MLC implemented a fee for service plan in 2006
Ban on upfront and trailing commissions soon to become law under the Australian Government Treasury. “Future of Financial Advice Reforms”
M2
Fair Dealing
Principles of fair dealing are commonly –
 Designing Products and services are suitable for the target client
 Presented by competent representations: quality advice and appropriate recommendations
 Customers receive clear, relevant and timely information so that they can make informed decisions
 A process for customer feedback and compliant that it independent and effective
Characteristics
 The temptation to favour the largest and most profitable clients
 Favouritism could take various forms: quality, quantity and timing
Important to Note
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 That treatment need not be equal
 Legitimate offerings can include
 Different Service Packages
 Unique needs to clients
 Exact timing responsibility
 Differentiation of services is fine, but
 not if it disadvantages or negatively affects clients
 only if different service levels are fully disclosed and accessible to everyone.
Regulations: Compliance Procedures
Policies & Regulation to assure fair dealing
1. Release of Information
2. Trading Processes
3. Transparency and review of practices
Release of Information
Disseminate non-public information as quickly as possible.
For lengthy and detailed reports, offer a flash summary
 Guidelines for price dissemination must be established
 Inform everyone as simultaneously as possible
Trading Processes
Restrict trading until all clients have a fair chance to review recommendation
Develop a fair process for Trade Allocation
Some common elements might include:
 All orders must be date and time stamped
 Have a process on a first in and first out basis, based on the time stamp
 Block trades receive the same executive price and commission
 Partially executed blocks should be allocated pro rata.
For Hot IPO issues, obtain indications of interest in advance
Do not withhold shares
Transparency and Review of Practices
 Disclose all trade allocation procedures to clients
 Review accounts systematically
 Disclose the presence of tiers of service.
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Ethical Risk – IPO Spinning
Spinning Defined
 Involves Investment Bankers allocating lucrative shares (usually at a preferred/discount price) in initial public offerings (IPOs) or other capital raisings
to senior executives at client companies.
 Why? Hopes to win lucrative corporate finance work in the future. Under-pricing the initial offering leads to opportunity to reward staff once sold
Position  Now illegal and the general consensus is that it is illegal.
M3
Suitability refers to whether a certain situation that an investment strategy meets the objectives and means of an investor.
Policies and Procedures that assume suitability
1. Client Identification
2. Investor Objectives
3. Investor Constraints
4. Performance Measurement Benchmarks
Policies and Procedures that assume fair performance representation
1. Consider the knowledge and sophistication of the audience
2. Present performance of a weighted composite of similar portfolio’s rather than a single benchmarks (peer performance)
3. Include terminated accounts as part of performance history (selection)
4. Include all relevant disclosures (hedged, after tax)
5. Maintain data and records used to calculate performance
Ethical Risk – Mortgages
Areas of concern in mortgage practices
 Mortgage commitments that don’t take into account wage, employment and position of the client
Accusations of
 Misleading marketing
 Hidden fees
 Risky terms
Regulatory developments following the GFC
 USA: FIRA and SEC
 AUSTRALIA: AUSTRAC
M4
Duties to the Employee
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Employees have the following duties
 Perform agreed tasks
 Report as required
 Work standard hours
 Obey laws and regulations
 Commitment to company values, codes and practices
 Respect confidentiality of information and practices
Employers generally the following duties
 Provide a safe working environment
 Provide adequate support, development and guidance
 Entitlements such as annual and sick leave
Protections for an Employer
Obligation of an employee that protects the Employer
1. Dealing on Personal Account – Trading whilst working for a bank is strictly regulated
2. Avoid Conflicts of Interest – Must advise of external directorships
3. Intellectual Property – Includes trade secrets, client lists and confidential information
4. Notice and Non-Competes – Notice periods and ‘gardening leave’
5. Solicitation of Staff – “Encouraging people to leave an organisation as one makes their exit” is usually detailed in the employment contract
Ethical Risk – Confidentiality & Whistleblowing
Whistleblowing refers to revealing wrongdoing within an organisation to the public or an authority.
Legal Position
 Protections for whistleblowers vary across countries
 Protections can include
 No victimisation
 Identity not disclosed
Lecture 7 – Conflicts of Interest
M1 – Investment Analysis (Due Diligence and Reasonable Effort)
The Role of an Analyst
To Study & Analyse an asset class to determine its intrinsic value through
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 Scrutinising financial reports
 Conducting interviews
To Evaluate whether or not the decision to invest in an asset class is an investment risk.
Analyst and their types
 Sell Side Analysts
 Buy Side Analysts
 Independent Analysts
Sell Side Analysts
Typically provide free services to prospective or current clients hoping to entice clients to trade securities with their IB firm.
Sell Side analysts are incentivised to make money through commission schemes achieved through brokerage operations.
Reasonable Effort
Requirements for issuing conclusions on research demand Reasonable Efforts to cover all pertinent issues.
Transparency is expected to be enhanced by Analysts providing supporting information to clients when making recommendations  achieved using 2nd or
3rd party research.
Reasonable Effort requires:
 Review of Assumptions
 Rigour of analysis
 Timeliness
 Objectivity and Independence
M2 – Communication with Current/Prospective Clients
How should Analysts communicate?
A range of aspects that analysts can consider are:
-Frequency
-Breadth
-Depth
-Mode
Research Reporting
1. Insight
2. Structure
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3. Style
4. Substance
5. Limitations
Research Analyst Best Practice
Clarity – Research should fair, clear and not misleading
Competence, conduct and personal integrity – Skill, care, diligence and integrity  reflect the opinion of the author/s
Review – In no case should the company be informal of recommendation or valuation
Competition, reflection – No restrictions on the provision of written and oral research by unaffiliated analysts.
Are Analysts Taken Seriously
Incentives of the analyst to be biased will be affected by reputational and legal considerations favouring honest disclosure.
 Analyst compensation will depend on quality
 Peer groups evaluating quality
 Aspiration to be listed in rankings
 Status and employability
 Threat of litigation
“Most investors, especially the professionals & semi-professionals think they can spot biases; some believe they can filter out biases to reach some degree
of objectivity.”
Unbiased analysts anticipate that the report will be discounted by investors and introduce the bias solely for the purpose of offsetting this discounting effect.
Biased analysts may introduce additional bias for the same reason.
What Analysts Should Keep
The data, the model, the process, the output to substantiate the scope of the research and reasons underlying the recommendations.
Record are property of the employer of the analyst and it is the employer’s obligation to keep those records – therefore included in the employees code of
conduct.
Records need to be of sufficient quality to recreate the report and arrive at the same recommendation. Regulators would often require this (for 5-7 years).
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M3 – Conflicts of Interest
A conflict of interest occurs when an individual or organisation has multiple interests, one of which could possibly corrupt the motivation for an act in the
other. A conflict of interest can only exist if a person or testimony is entrusted with some impartiality; some trust is necessary to create it. The presence of a
conflict of interest is independent from the execution of impropriety. Therefore, a conflict of interest can be discovered and voluntarily defused before any
corruption occurs.

Investment banking can involve inherent conflicts of interest that must be managed if they cannot be avoided. These conflicts are most likely to arise in
cases where the firm has a wide range of activities including stockbroking, securities trading and underwriting. In such cases, investors and regulators may
be concerned that the equity research analysts’ recommendations on which shares to buy or sell may be influenced by their colleagues who are seeking to
attract or retain business in underwriting or corporate advisory activities. The standard approach to managing such conflicts of interest is to employ internal
barriers – known as information barriers or, more frequently, Chinese walls – to limit the flow of confidential client information between departments.

Concerns about the effectiveness of Chinese walls were widely publicised in the US in 2001. One outcome was that Merrill Lynch agreed to pay a fine of
US$100 million because of allegations that its broking analysts issued overly optimistic reports on the shares of companies that were clients of its
investment banking operation.

Examples
Investment Banking Relationships
• The analyst’s firm may be underwriting the offering (financial and reputation incentive to assure a successful offering) – analysts partake in due diligence
research
• Client companies prefer favourable research reports - nurtures a lucrative long-term IB relationship
• Positive reports attract new clients – in competition for clients the tone of coverage is important
Brokerage Commissions
• Brokerage firms don’t charge for research, but positive reports may provide indirect money by generating purchases and sales of covered securities Analyst
Compensation
• Typical compensation arrangements put pressure on analysts, e.g. by linking compensation to the number of IB deals
Ownership Interests in the Company • Analysts may own significant positions in the companies they cover.

Detecting conflicts of interest
Prospective investors may need to do their own due diligence:
• Identify the underwriter (order of listing with lead and co-underwriters indicates their financial interest)
• Research ownership interests
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• Understand the meaning of lock-ups (lock-up agreements prohibit company insiders from selling their shares for a set period of time without the
underwriter’s permission)
• Read and understand all disclosures
• Read independent reports

Managing conflicts of interest
No Promises of Favourable Research
• Prohibits analysts from offering a favourable rating to attract IB opportunities.
• “Quiet periods” barring a firm that is acting as a manager of a securities offering from issuing a report within 40 days of an IPO
Limitations on Relationships and Communications
• Prohibit analysts from being supervised by the IB department.
• IB personnel are prohibited from discussing research with analysts prior to distribution unless monitored by legal/compliance
• Prohibit analysts from sharing draft research reports with target companies (other than checking facts after approval from legal/ compliance)
Analyst Compensation and Firm Compensation
• Bars security firms from tying analyst compensation to specific IB transactions (if based on IB revenues, it needs full disclosure)
• Requires disclosure in a research report if the firm manages a public offering or received IB services compensation from the company analysed. Personal
Trading Restrictions and Disclosure of Financial Interest
• Bars analysts from investing in a company prior to its IPO if covered – includes “blackout periods” prohibiting analysts from trading around research report
and against recent recommendations
• Requires full disclosure of ownership of shares of recommended companies
Disclosure in Research Report of Firm Ratings
• Requires clearly explaining the meaning of all rating terms. And need to provide the percentages in buy/hold/sell ratings, and compare with historical price
movements.
Disclosure during Public Appearance of Analyst
• Television and radio interviews require similar disclosures as those mentioned above

Disclosure
Effective disclosures need to be clear and upfront and must be made in plain language and effectively communicate the information to:
Clients – you must maintain objectivity when giving investment advice or taking investment action; if there is potential for possible impairment of
objectivity, then disclosure provides clients to judge motives and possible biases for themselves.
Employers – you must give the employer sufficient information to assess the possibility of a conflict of interest
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