Ethics In Finance

Ethics in general is concerned with human behavior that is acceptable or "right" and that is not acceptable or "wrong" based on conventional morality. General ethical norms encompass truthfulness, honesty, integrity, respect for others, fairness, and justice. They relate to all aspects of life, including business and finance. Financial ethics is, therefore, a subset of general ethics.

Ethical norms are essential for maintaining stability and harmony in social life, where people interact with one another. Recognition of others' needs and aspirations, fairness, and cooperative efforts to deal with common issues are, for example, aspects of social behavior that contribute to social stability. In the process of social evolution, we have developed not only an instinct to care for ourselves but also a conscience to care for others. There may arise situations in which the need to care for ourselves runs into conflict with the need to care for others. In such situations, ethical norms are needed to guide our behavior. As Demsey (1999) puts it: "Ethics represents the attempt to resolve the conflict between selfishness and selflessness; between our material needs and our conscience."

ETHICAL VIOLATIONS

The most frequently occurring ethical violations in finance relate to insider trading, stakeholder interest versus stockholder interest, investment management, and campaign financing. Businesses in general and financial markets in particular are replete with examples of violations of trust and loyalty in both public and private dealings. Fraudulent financial dealings, influence peddling and corruption in governments, brokers not maintaining proper records of customer trading, cheating customers of their trading profits, unauthorized transactions, insider trading, misuse of customer funds for personal gain, mis-pricing customer trades, and corruption and larceny in banking have become common occurrences.

Insider trading is perhaps one of the most publicized unethical behaviors by traders. Insider trading refers to trading in the securities of a company to take advantage of material "inside" information about the company that is not available to the public. Such a trade is motivated by the possibility of generating extraordinary gain with the help of nonpublic information (information not yet made public). It gives the trader an unfair advantage over other traders in the same security. Insider trading was legal in some European countries until recently. In the United States, the 1984 Trading Sanctions Act made it illegal to trade in a security while in the possession of material non-public information. The law applies to both the insiders, who have access to nonpublic information, and the people with whom they share such information.

Campaign financing in the United States has been a major source of concern to the public because it raises the issue of conflict of interest for elected officials in relation to the people or lobbying groups that have financed their campaigns. The United States has a long history of campaign finance reform. The Federal Election Commission (FEC) administers and enforces the federal campaign finance statutes enacted by the Congress from time to time. Many states have also passed lobbying and campaign finance laws and established ethics commissions to enforce these statutes.

ETHICAL CODES

Approaches to dealing with ethical problems in finance range from establishing ethical codes for financial professionals to efforts to replace the rational-maximizer (egoistic) paradigm that underlies the modern capitalist system by one in which individuals are assumed to be altruistic, honest, and basically virtuous.

It is not uncommon to find established ethical codes and ethical offices in American corporations and in financial markets. Ethical codes for financial markets are established by the official regulatory agencies and self-regulating organizations to ensure ethically responsible behavior on the part of the operatives in the financial markets.

One of the most important and powerful official regulatory agencies for the securities industry in the United States is the Securities and Exchange Commission (SEC). It is in charge of implementing federal securities laws, and, as such, it sets up rules and regulations for the proper conduct of professionals operating within its regulatory jurisdiction. Many professionals play a role within the securities industry, among the most important of which are accountants, broker-dealers, investment advisers, and investment companies. Any improper or unethical conduct on the part of these professionals is of great concern to the SEC, whose primary responsibility is to protect investor interests and maintain the integrity of the securities market. The SEC can censure, suspend, or bar professionals who practice within its regulatory domain for lack of requisite qualifications or unethical and improper conduct. The SEC also oversees self-regulatory organizations (SROs), which include stock exchanges, the National Association of Security Dealers (NASD), the Municipal Securities Rulemaking Board (MSRB), clearing agencies, transfer agents, and securities information processors. An SRO is a membership organization that makes and enforces rules for its members based on the federal securities laws. The SEC has the responsibility of reviewing and approving the rules made by SROs.