A Report On Deviations In Ethics And Finance

Prepared by,

Nemil Shah & Group

 What is ethics all about?

Ethics is about answering Socrates' question ―What ought one to do?‖ This is a
practical question ... what do I do here and now? ... What should anyone do in
my situation? It is a question that it is almost impossible to avoid.

The ethical dimension is an area of ‗greys‘ rather than ‗blacks and whites‖:

One always encounters the genuine ethical dilemma

It is sometimes a matter of choosing the least bad alternative

Ethics is about relationships. The ultimate test of our ethics arises in

circumstances when we have to weigh the interests of ourselves and others.

It is more often between what is right and less right - in other words between
shades of grey. This increases the need for organizations to adhere to a strong set
of values to steer them through the minefield of ethical choices with which they are
faced as they make business decisions. It is also necessary to ensure that the
behavior of the organization is in practice aligned with these values and that
employees buy into them, so that the organization actually practices what it
preaches.

Following are the points where finance deviates with ethics.

Mergers and Takeovers

The merger mania of 1980s put top management on the defensive as predators
sought takeover targets. Hostile takeover activity has dissipated in recent years, for
a variety of reasons, but the ethical issues surrounding acquisitions and mergers
and the ethically questionable conduct that is often involved remain as relevant as
ever. The ethical conduct of Target Company‘s top management is often
overlooked.

The shareholders of a modern publicly held corporation buy and sell their shares
freely, though ordinarily in small quantities and without major consequence for the
corporation itself. Occasionally, a new owner – typically another firm will acquire
a large fraction of a corporation‘s shares, elect a new board of directors, replace or
absorb its top management, and alter its methods of doing business. Consequently,
when a substantial fraction of shares does change hands – through a negotiated
acquisition, market purchase or tender offer – the new owner expects to gain.

Mergers, acquisitions and takeovers often imply dramatic changes for employees,
competitors, customers and suppliers. Not surprisingly, the market for corporate
control has generated controversy and is frequently regulated by law or business
custom. During most of the twentieth century, critics of mergers and acquisitions
in the US pointed to the danger of monopoly and increased concentration. Partly in
response to the emergence of the new control transactions such as the hostile
takeover and leveraged buyout, more recent criticism has focused on the
consequences of corporate productivity, profitability, and employee welfare.
Subject to qualifications, the market for corporate control reallocated productive
assets – in the form of going concerns – to the highest bidder. In cases where
bidder uses his own money or acts on behalf of the bidding firm‘s shareholders, the
market for corporate control pays a paradoxical role. It simultaneously provides (1)
a means by which managers may acquire companies using other people‘s money
and (2) a means by which they may themselves be disciplined or displaced.

When you buy another company you are making an investment and the basic
principles of capital investment decisions apply. You should go ahead with the
purchase that makes a net contribution to shareholders wealth. However many
factors other than simply the direct financial costs and benefits of the transaction
will have to be considered.

Ethical issues in mergers and acquisitions.

With the recent rash in mergers and friendly and unfriendly takeovers, two
important issues have not received sufficient attention as questionable ethical
practices. One has to do with the rights affected in mergers and acquisitions and
the second concerns the responsibilities of shareholders during these activities.
Although employees are drastically affected by a merger or an acquisition because
in almost every case a number of jobs are shifted or even eliminated, employed at
all levels are usually the last to find out about a merger transaction and have no
part in the takeover decision. Second, if shareholders are the fiduciary beneficiaries
of mergers and acquisitions, then it would appear that they have some
responsibilities or obligations attached to these benefits, but little is said about such
responsibilities.

With the recent rash of mergers and friendly and unfriendly takeovers, questions
have been raised concerning the ethical propriety of these actions. Some of these
have to do with the tactics companies engage in when trying to acquire a company
or when trying to avoid being acquired. These include so called ―poison pill‖
tactics and the institution of golden parachuets by the corporations that are
threatened with acquisitions and the usual anti-trust problems.

Such tactics include the following:

 The target adds to its charter a provision which gives the current
shareholders the right to sell their shares to the acquirer at an increased price
(usually 100% above recent average share price), if the acquirer's share of
the company reaches a critical limit (usually one third). This kind of poison
pill cannot stop a determined acquirer, but ensures a high price for the
company.
 The target takes on large debts in an effort to make the debt load too high to
be attractive—the acquirer would eventually have to pay the debts.
 The company buys a number of smaller companies using a stock swap,
diluting the value of the target's stock.
 The target grants its employees stock options that immediately vest if the
company is taken over. This is intended to give employees an incentive to
continue working for the target company at least until a merger is completed
instead of looking for a new job as soon as takeover discussions begin.
However, with the release of the ―golden handcuffs‖, many discontented
 employees may quit immediately after they've cashed in their stock options.
This poison pill may create an exodus of talented employees. In many high-
tech businesses, attrition of talented human resources often means an empty
shell is left behind for the new owner.

One such example is when

PeopleSoft guaranteed its customers in June 2003 that if it were acquired within
two years, presumably by its rival Oracle Corporation, and product support were
reduced within four years, its customers would receive a refund of between two
and five times the fees they had paid for their PeopleSoft software licenses. The
hypothetical cost to Oracle was valued at as much as US$1.5 billion. The move
was opposed by some PeopleSoft shareholders who believed the refund guarantee
flagrantly opposed their interests as shareholders. PeopleSoft allowed the
guarantee to expire in April 2004

Other issues include the rights of bondholders on both sides of a merger or

acquisition, rights that are often considered secondary in light of shareholder
interests, and the question of the rights of individual stockholders who are usually
neglected in face of institutional shareholder power!

However, two important issues have not surfaced as questionable practices

deriving from mergers and takeovers, one having to do with the rights of
employees in mergers and second concerning the responsibilities of shareholders
during these activities. Employees in the acquiring and in the acquired company
are expected to carry out their job responsibilities both during the process of the
merger or takeover and after its completion. They are supposed to carry on as if
nothing had happened, despite rumors, threats of their jobs, or upheavals on all
levels of management. Although employees are drastically affected by a merger or
an acquisition because in almost every case a number of jobs shifted or even
eliminated after a merger, in fact except for top management, employees at all
levels are usually last to find out about a merger transaction. Yet few
commentators have thought this was an issue, and almost nothing has been said
about the rights of employees during and after a merger or acquisition. It is as if the
question of how employees are affected in these sorts of transactions was
unimportant or incidental to the fiduciary benefits or losses of the negotiations.
Second, although a merger is said to be for the fiduciary benefit of shareholders of
both parties, and indeed, this is allegedly the primary justification for a merger or
an acquisition, insufficient attention has been paid to the responsibilities of
shareholders in these activities.

Management Buy Outs

A management buyout (MBO) is a form of acquisition where a company's existing

managers acquire a large part or all of the company.

Management buyouts are similar in all major legal aspects to any other acquisition
of a company. The particular nature of the MBO lies in the position of the buyers
as managers of the company, and the practical consequences that follow from that.
In particular, the due diligence process is likely to be limited as the buyers already
have full knowledge of the company available to them. The seller is also unlikely
to give any but the most basic warranties to the management, on the basis that the
management knows more about the company than the sellers do and therefore the
sellers should not have to warrant the state of the company.

In many cases the company will already be a private company, but if it is public
then the management will take it private.

Some concerns about management buyouts are that the asymmetric information
possessed by management may offer them unfair advantage relative to current
owners. The impending possibility of an MBO may lead to principal-agent
problems, moral hazard, and perhaps even the subtle downward manipulation of
the stock price prior to sale via adverse information disclosure - including
accelerated and aggressive loss recognition, public launching of questionable
projects and adverse earning surprises. Naturally, such corporate governance
concerns also exist whenever current senior management is able to benefit
personally from the sale of their company or its assets. This would include, for
example, large parting bonuses for CEOs after a takeover or management buyout.

Since corporate valuation is often subject to considerable uncertainty and

ambiguity, and since it can be heavily influenced by asymmetric or inside
information, some question the validity of MBOs and consider them to potentially
represent a form of insider trading.

The mere possibility of an MBO or a substantial parting bonus on sale may create
perverse incentives that can reduce the efficiency of a wide range of firms - even if
they remain as public companies. This represents a substantial potential negative
externality.

The Purpose of an MBO

The purpose of such a buyout from the managers' point of view may be to save
their jobs, either if the business has been scheduled for closure or if an outside
purchaser would bring in its own management team. They may also want to
maximize the financial benefits they receive from the success they bring to the
company by taking the profits for themselves. This is often a way to ward off
aggressive buyers.

For example

On September 17, 2007, Sir Richard Branson announced that the UK arm of Virgin
Megastores was to be sold off as part of a Management buyout, and from 07, will
be known by a new name, Zavvi.

Why do MBOS occur?

Another reason management buyouts occur is that management can run its
business in the most profitable way. As profit-seeking entrepreneurs, management
shops around for the lowest priced goods and services. Any savings are realized as
extra cash flow in the form of profits or debt-reducing money. Entrepreneurs are
careful about costs. Extra expenses come out of management's pockets. Sheehan
notes that "for executives of public companies, it is always so easy to grab a cab--
or the corporate jet--at company expense. Once you're a manager-owner, you may
walk the seven blocks or take Peoples Express."
Hostile takeovers can be moderately reduced by MBOS. In fact, in 1983 top
executives of Signore Corp., a packaging-materials manufacturer repelled a hostile
takeover by financier Victor Posner. The stumbling block of Posner's attempt was a
$430-million management buyout. Another example of a hostile takeover attempt
blocked by a management buyout is the Uniroyal case. At Uniroyal's annual
meeting in the spring of 1985, Carl Icahn proposed a takeover. As a result,
Uniroyal hastily went private. Later Joseph P. Flannery, chief executive of
Uniroyal, commented, "We had talked about private ownership in a general way
previously, but frankly I think we were too conservative to have taken the risk of a
leveraged buyout on our own initiative."

In a buyout, management becomes an active member on both sides of the table. It

acts on behalf of the shareholders to determine whether a sale is in their best
interest and seeks the best possible price. It also acts on its own behalf as a profit-
seeking entrepreneur. The morality of such a transaction has been questioned, but
one thing is certain: the stockholders stand to gain a hefty profit. Investment
bankers play a key role in defining the premium price that must be offered to
persuade stockholders to part with their shares.

Flaws in MBOs

Although previous ethical analyses of management buyouts have presented useful

insights, they have been flawed in three major ways.
First, they define the transaction too narrowly, emphasizing the going private
aspect and ignoring the leveraged aspect. Leveraging alters the nature of the
transaction substantially and warrants additional ethical analysis.

Second, these previous analyses ignore the impact of buyouts on non-stockholder

constituents of the firm, an omission which renders their implicit utilitarian
approach incomplete.

Third, these analyses do not include Rawlsian, libertarian, or Kantian perspectives

on ethics.

MBOs and ethic

Management buyouts have been a favorite target of corporate governance types for
years but the critics may have a new line of attack—criticizing managers for
scuttling deals.

The traditional criticism of management buyouts—where a company‘s senior

executives cooperate with financiers to buy a company from public shareholders
and take it private—has been that management could exploit shareholders by
buying the company on the cheap and discouraging other bidders. When the
buyout market was firing on all cylinders, objecting to management buyouts on
these grounds was a favorite past-time of self-styled shareholder advocates. But
now that the buyout market has ground to a crawl—if not a complete halt—the
conflicted role of buying and selling a company same time could be working the
other way.

Junk Bonds and Leveraged Financing

Bonds

Bonds usually generate return by their interest rate, which is paid at certain
specified intervals to the bondholder. bonds have the advantage of being a debt
instrument; if the issuing company is declared bankrupt, all debt, including debt
instruments such as bonds, have much higher priority in being paid from the
company‘s liquidation than any instrument reflecting ownership, such as stocks.

Bonds are generally classified into two groups - "investment grade" bonds and
"junk" bonds. Investment grade bonds include those assigned to the top four
quality categories by either Standard & Poor's (AAA, AA, A, BBB) or Moody's
(Aaa, Aa, A, Baa).

Junk bonds are collateralized debt obligations. (Collateralized Debt Obligations are
sophisticated financial tools that repackage individual loans into a product that can
be sold on the secondary market. These packages consist of auto loans, credit card
debt, or corporate debt. They are called collateralized because they have some type
of collateral behind)

Let‘s see how junk bonds function in market:

 A not so good creditworthy client comes to an agency for home loan

  They provide him , with an assumption that real estate prices will always
soar up,
 And they are just intermediary who charge commission , loan would be
financed by bank
 Bank collect all the mortgages repack them as CDO
 They bifurcate it into various parts depending open risk involved and rates
offered
 They get it covered under insurance and get good ratings by agencies
 Investors interested in high ranked and high yield bonds buy it.
Suddenly real estate bubble breaks down and bonds hold no more value

Suddenly real estate bubble breaks down and bonds hold no more value

This crash of junk bond market has led to high cash crunch and loss in trust and
faith of investors.

Few anecdotes make it far clearer

1. You know you shouldn't. Your CPA wouldn't approve. Your wife would be
furious if she found out. The guilt would consume you. Still... you can't help
casting a lustful glance at Junk Bonds with their 10-12% rate of return. Just
remember... flashy investments usually go up in smoke, and when these
babies fall, they fall hard. They're called "junk" for a reason.

2. "I think the Securities and Exchange Commission should set much tougher
standards. For instance, when investors lose money, instead of stockbrokers
 sending them letters of reassurance, they should have to send them letters
saying, 'Here, take some of mine.'"

Ethical Issues

Ethical questions associated with junk bonds are to do with the risk to the business,
effects of possible failure to repay very high levels of debt on the business and its
stakeholders-its employees, suppliers, share holders etc. the risk of failure means
the risk of job loss , unpaid bills. Yet if taking this risk is the only way the project
can be financed and people associated with the business know this and are
prepared to go forward on this basis there is nothing inherently unethical about the
proceedings .if the risk were transferred to employees or banks or suppliers
,however ,while owners continue to take the returns this would be unethical .

Leveraged Finance

Leveraged finance is funding a company or business unit with more debt than
would be considered normal for that company or industry. More-than-normal debt
implies that the funding is riskier, and therefore more costly, than normal
borrowing. As a result, levered finance is commonly employed to achieve a
specific, often temporary, objective: to make an acquisition, to effect a buy-out, to
repurchase shares or fund a one-time dividend, or to invest in a self-sustaining
cash-generating asset.

Although different banks mean different things when they talk about leveraged
finance, it generally includes two main products - leveraged loans and high-yield
bonds. Leveraged loans, which are often defined as credits priced 150 basis points
or more over the London interbank offered rate, are essentially loans with a high
rate of interest to reflect a higher risk posed by the borrower. High-yield or junk
bonds are those that are rated below "investment grade," i.e. less than triple-B.

A key instrument in much of leveraged finance, particularly in leveraged buy-outs,

is mezzanine or "in between" debt. Mezzanine debt has long been used by mid-cap
companies in Europe and the US as a funding alternative to high yield bonds or
bank debt. The product ranks between senior bank debt and equity in a company's
capital structure, and mezzanine investors take higher risks than bond buyers but
are rewarded with equity-like returns averaging between 10 and 20 per cent.
Companies that are too small to tap the bond market have been the traditional users
of mezzanine debt, but it is increasingly being used as part of the financing
package for larger leveraged acquisition deals. Although mezzanine has been more
expensive for companies to use than junk bonds, the low coupons coupled with
high returns often makes some sort of mezzanine or hybrid debt an essential buffer
between senior lenders and the equity investors.

There are often different layers of finance involved in leveraged financing. These
range from a senior secured bank loan or bond to a subordinated loan or bond. A
large part of the role of leveraged financiers is to calculate how each type of
finance should be raised. If they overestimate the ability of the company to service
its debt, they may lend too much at a low margin and be left holding loans or
bonds they cannot sell to the market. If the value of the company is
underestimated, the deal may be lost.

Leveraged Finance Risks

 Credit risks are concerned with the business and its market. Financial risks
which lie within the economy as a whole, for instance, interest rates, foreign
exchange rates and tax rates.
 Structural risks are risks created by the actual provision of finance including
legal, documentation and settlement risks.
 Liquidity risks are those associated with the inability of a leveraged
company to refinance itself in tight credit conditions

Contribution of media in leveraged financing:

Roughly 25 new income trust offerings have lost more than half their value in the
past few years after being sold mostly to retail investors. The common reason
behind the $2.1- billion in losses is clear: pure, unmitigated greed. Greed by
investors, greed by underwriters, lawyers, accountants and greed by the media.

We should focus on that last cohort first, because without the greed of the media,
investors wouldn't have been burned as badly as they were by income trust
investments over the past few years

It seems investors have forgotten that the media are businesses too. They survive
on advertising dollars, and they rely on content to fill their pages and airtime. In
the case of income trusts, the two frequently went hand in hand. Both national
newspapers ran several insert sections dedicated solely to income trusts

The simple reality is that, as the media remained largely silent, underwriters not
only promoted high-risk trusts at exaggerated prices, but they stressed non-existent
safety, and misleading yield figures.

Thus any misrepresentation either by rating agencies, media or banks leads to

losses to various stakeholders. Thus it is unethical on the part of bond issuers.

Insider dealing

Insider dealing can be understood as illegal share dealings by employees of a

company where they have used confidential price-sensitive information for their
own gain or the gain of their associates. It is buying or selling of a security by
someone who has access to material, nonpublic information about the security.

The inside dealer does not have to work for the company for his dealing to be an
offence. Corporate executives are termed as ‗insiders‘ but some ‗outsiders‘ can
also be charged with insider trading. Some such outsiders are a printer who has
been able to identify the targets of takeovers from legal documents that were being
prepared, a financial analyst who uncovered a huge fraud at a high flying firm and
advised his clients to sell, a stockbroker who gained some confidential information
through family gossip. So a stockbroker, or merchant banker, who knows about an
impending takeover deal who buys shares in the target company with the intention
of making a profit, is guilty. If he gets a friend to buy the shares, he is still guilty.

Market Abuse and Insider Dealing - What's the Difference?

Insider dealing is a subset of market abuse, which covers many different types of
abuse in public markets. Essentially, 'inside information' is specific confidential
information which would have an effect on the price of a publicly traded
company's shares, bonds or derivatives if made public. Insider dealing is acting on
this information by, for instance, buying or selling shares in the company
concerned. An example would be a takeover offer of company X at £1 per share by
company Y. Before the offer is made public, the market price of shares in X is, say
80p, and as soon as the takeover is announced the market price will rise to near £1,
the level of the offer from Y. If an insider to the transaction is able to buy shares in
X at 80p (because the market doesn't know about the impending offer at £1) and
can sell them after the public announcement at £1, then the insider stands to make
a tidy, low-risk profit in a short period of time.

Inside information is not exclusively related to takeovers. Inside information could

be, for example, non-public news about a company's product sales or a problem
leading to litigation. The pharmaceutical industry is a good example of an area
where bad news about products can lead to falls in the price of a company's shares.
It is possible through the use of derivatives to profit from a fall, as well as a rise, in
the price of shares or bonds

To better understand how and when insider dealing offence may arise let us take
the example of a bank which lends money and may get access to price sensitive
information. Use of such information may be a criminal liability. For this lets
consider an abstract from the paper published by The Financial Law Panel (FLP)
outlining the risk to lenders of committing insider dealing offences if they enforce
security over listed securities while in possession of price sensitive information and
highlighting situations in which such a problem may arise for the banks.

Criminal liability

Broadly, it is a criminal offence for anyone who has price sensitive information
about a company to deal in its listed securities, to arrange or encourage someone
else to do so, or to disclose the information unless disclosure is in the proper
performance of the office of the individual concerned (Part V, Criminal Justice Act
1993 "the Act").
The offences can only be committed by individuals - not the institutions which
hold charges over listed securities. It is not necessary that the decision takers
should know the inside information, merely that they should be aware that other
officers of the bank are prohibited from dealing.

When might the problem arise?

There is thus a conflict between a bank's need for information about its borrower
and its wish to ensure that it can enforce security without running the risk of
committing an offence under the Act. The paper sets out the most common
situations in which the problem might arise:
* The bank lends to a holding company which has a listed subsidiary. The holding
company charges shares in the subsidiary as security for the loan.
* The bank makes a personal loan to a director or controlling shareholder of a
listed company and as security for his obligations under the loan he charges his
shares in the listed company to the bank. The listed company may or may not be a
borrower from the bank.
* The bank lends to a listed company. The company's holding company guarantees
the obligations of the borrower and as security for its guarantee charges to the bank
its shares in the listed company.
In the course of their dealings, the borrower(s) or guarantor will almost certainly
give to the lending bank information relating to the listed company. The bank is
likely to encourage this disclosure and will therefore risk being made an insider.

Ethical issues regarding insider trading

The two rationales that support the argument against insider trading .

One it is based on property rights and holds that those who trade on material,
nonpublic information are stealing away the property that belongs to corporations.
Some companies may sell this information to favored investors, employees may
use it for their benefit, and company may use it to buy back its own shares. This
might be an inexpensive way to encourage employees to get more valuable
information for the firm but at the same time this may discourage investors to
invest in such a company as they are at a disadvantage. It also raises the ethical
question about the harm done to the investing public at large.
The second rationale is based on fairness; it holds that traders who have inside
information have an unfair advantage over other investors as a result making stock
market not a level playing field. Stock market regulation requires that both buyers
and sellers of a stock should have sufficient information to make rationale choices.
Trade at stock market takes place only if buyers and sellers have different
information about the stock that leads them to different conclusions about the
stock‘s worth. However using inside information is objectionable as an outsider
how much ever diligent he may be is barred from access to such sensitive
information.

Some economists argue that stock market would be more efficient without the law
against insider trading. Argument given in support of this is that information would
be registered in the market more quickly and at a less cost than the alternative of
leaving the task to research by stock analyst. These arguments look at the cost of
registering information only and not at the adverse consequences of legalized
insider trading. Legalized insider trading would discourage some investors who
view it as an unlevel playing field or will be forced to adopt costly defensive
measures. A firm may tailor the release of information to maximize the benefit of
insiders. This may undermine the relation of trust that is essential for business
organizations. Legalized insider trading will breach the fiduciary duty of every
insider to serve the interest of the company and its shareholders. The use of
information acquired while serving as a fiduciary for personal gain is a violation of
this duty. This would be a breach of professional ethics.

Slippage of confidential information may not be intentional. It may be a matter of

indiscretion, of one person or several people saying individually innocent things
which put together may turn out be something of use for already informed person.
However there are employees who use this information consciously for their own
benefit. As stated by MICHAEL FELTHAM, head of the stock exchange‘s insider
dealing investigation group there is a percentage of people who will misuse the
information if they are given an opportunity. This raises ethical concerns about the
loyalty of individual towards the firm, and questions the assumptions of
confidentiality and professionalism. The base or undercurrent of business is shaken
if such values are not upheld. Trading on information obtained by virtue of
conscientious observation analysis, or assiduous investigation, must be
distinguished from trading on information acquired through a breach of confidence
or theft. The trader‘s relationship to the source of the information and to the subject
of the information is therefore essential to determining the ethical status of any
case of insider trading. Information acquired incidentally or accidentally, trading
on it may not be unethical. However insider trading is not a victimless crime, the
shareholders whose corporate information has been misappropriated are the
victims of such crime.

It is difficult to hold someone guilty for insider trading. It requires that the jury be
satisfied that the information received was price sensitive, that the information was
actually passed to the defendant, that the defendant knew that the information was
confidential and price sensitive, that the defendant knew that the information was
unpublished ,and that the defendant used the information to profit or to avoid loss.
The definition requires such complications and makes it difficult to prosecute. The
problem of legal enforcement is compounded by the fact that it is difficult to make
distinction between an acceptable and unacceptable ‗insider‘.
BANKING

We can't think of any industry where ethics would be more important than in
banking -- partly because financial institutions are such a crucial part of the
infrastructure of the entire world economy, and their trustworthiness is bound to
have serious implications for countless individuals and institutions. Further, banks
(like charities) depend almost entirely on trust to sustain their business -- a bank
that shows itself not to be trustworthy will very quickly find itself short of
customers. Of course, unlike charities, the trust we place in banks is sustained in
part by a pretty significant regulatory system.

What are the main functions of the banks??

The main function of the bank is mainly borrowing and lending of money. Here the
real question arises that do banks have responsibilities to borrowers??

Should people be able to take on as much credit as‘ they can raise without the
lending institutions being prepared to suggest any limit to what borrowers can
afford?
Here there is a dilemma for the bank whether to lend more money for the sake of
profitability or be a little conservative in lending money??

The answer is simple the banks should lend appropriate amount of money after
properly scrutinizing the repayment capacity of the client. Unfortunately the above
thing didn‘t happen in case of most of the Investment Banks or I-Banks of America
and the greed to earn more money led to a complete collapse of the economy as
loans were granted to people with low credibility and without proper security. The
main belief among the banks was that the prices of the houses would always rise
but when the bubble bursted it was all ugly & Gloomy as banks were not in a
position to recover the money which were lent. The losses are expected to be
around U.S. $ 3 trillion

As the American crisis has demonstrated, ethical values are still not firmly
entrenched and followed in many banks in the region. Bribery and corruption have
been one of the root causes of the banking problems.

Here's a very interesting anecdote that describes how an 'asset bubble'

builds up and what are its consequences

Anecdote

Once there was a little island country. The land of this country was the tiny island
itself. The total money in circulation was 2 dollar as there were only two pieces of
1 dollar coins circulating around.
1) There were 3 citizens living on this island country. A owned the land. B and
C each owned 1 dollar.

2) B decided to purchase the land from A for 1 dollar. So, A and C now each
own 1 dollar while B owned a piece of land that is worth 1 dollar.
The net asset of the country = 3 dollar.

3) C thought that since there is only one piece of land in the country and land is
non produce able asset, its value must definitely go up. So, he borrowed 1 dollar
from A and together with his own 1 dollar, he bought the land from B for 2
dollar.

A has a loan to C of 1 dollar, so his net asset is 1 dollar.

B sold his land and got 2 dollar, so his net asset is 2 dollar.
C owned the piece of land worth 2 dollar but with his 1 dollar debt to A; his net
asset is 1 dollar.
The net asset of the country = 4 dollar.

4) A saw that the land he once owned has risen in value. He regretted selling it.
Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar from B and
acquired the land back from C for 3 dollar. The payment is by 2 dollar cash
(which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A
now owned a piece of land that is worth 3 dollar. But since he owed B 2 dollar,
his net asset is 1 dollar.

B loaned 2 dollar to A. So his net asset is 2 dollar.

C now has the 2 coins. His net asset is also 2 dollar.
The net asset of the country = 5 dollar. A bubble is building up.

(5) B saw that the value of land kept rising. He also wanted to own the land. So
he bought the land from A for 4 dollar. The payment is by borrowing 2 dollar
from C and cancellation of his 2 dollar loan to A.

As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2
dollar.
B owned a piece of land that is worth 4 dollar but since he has a debt of 2 dollar
with C, his net Asset is 2 dollar. C loaned 2 dollar to B, so his net asset is 2
dollar.
The net asset of the country = 6 dollar. Even though, the country has only
one piece of land and 2 Dollar in circulation.

(6) Everybody has made money and everybody felt happy and prosperous.

(7) One day an evil wind blowed. An evil thought came to C's mind. 'Hey, what
if the land price stop going up, how could B repay my loan? There is only 2
dollar in circulation, I think after all the land that B owns is worth at most 1
dollar only.'
A also thought the same.

(8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar coins;
his net asset is 2 dollar. B owed C 2 dollar and the land he owned which he
thought worth 4 dollar is now 1 dollar. His net asset becomes -1 dollar.

C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset is still 2
dollar, his Heart is palpitating.

The net asset of the country = 3 dollar again.

Who has stolen the 3 dollar from the country? Of course, before the bubble
burst B thought his land worth 4 dollar. Actually, right before the collapse, the
net asset of the country was 6 dollar in paper. His net asset is still 2 dollar, his
heart is palpitating.
The net asset of the country = 3 dollar again.

(9) B had no choice but to declare bankruptcy. C as to relinquish his 2

dollar bad debt to B but in return he acquired the land which is worth 1
dollar now.

A owns the 2 coins; his net asset is 2 dollar. B is bankrupt; his net asset
is 0 dollar. (B lost everything) C got no choice but end up with a land
worth only 1 dollar (C lost one dollar) The net asset of the country = 3
dollar.

There is however a redistribution of wealth. A is the winner, B is the loser, C is

lucky that he is spared.

A few points worth noting -

(1) when a bubble is building up, the debt of individual in a country to one
another is also building up.
(2) This story of the island is a close system whereby there is no other
country and hence no foreign debt. The worth of the asset can only be
calculated using the island's own currency. Hence, there is no net loss.

(3) An over damped system is assumed when the bubble burst, meaning the
land's value did not go down to below 1 dollar.

(4) When the bubble burst, the fellow with cash is the winner. The fellows
having the land or extending loan to others are the loser. The asset could
shrink or in worst case, they go bankrupt.

(5) If there is another citizen D either holding a dollar or another piece

of land but refrain to take part in the game? At the end of the day, he will
neither win nor lose. But he will see the value of his money or land goes up
and down like a see saw.

(6) When the bubble was in the growing phase, everybody made money.

(7) If you are smart and know that you are living in a growing bubble, it is
worthwhile to borrow money (like A) and take part in the game. But you must
know when you should change everything back to cash.

(8) Instead of land, the above applies to stocks as well.

(9) The actual worth of land or stocks depends largely on psychology.

Conclusion

Banks need to consider how their actions - anywhere in the world - will affect their
customers or be perceived by them. But customers are not the only people the
banks have to worry about. They also need to take account of regulators in the
various jurisdictions in which they operate, and the fact that regulatory standards
may shift over time

In the current social environment there are many who would argue that a genuine
commitment to ethics is an unrealizable ideal. Many think that sound ethical
principles are fine in theory but that they can't really be applied in practice. To try
to do so is to be nostalgic. They say that to promote virtue is to be old fashioned, to
hark back to ideas only useful in a different era. They ask us to be 'realistic' and to
embrace the 'modern' way of doing things. This plea is often nothing more than an
ill disguised call to allow for the survival of the fittest.

Perhaps such people are right. Perhaps a dog-eat-dog world will be the most
efficient. And perhaps efficiency is the only value that we need to embrace in the
search for a worthwhile life. Or perhaps efficiency is only one of a number of
important values that we must learn to juggle across an unpredictable landscape.

Those of us who are serious about the need to make ethical considerations an
explicit concern in our daily lives must face up to this challenge. After all, what if
our critics in the market place are right? What if the prime (and exclusive) aim in
life really is to maximize our satisfaction of wants (and not just needs)? What if the
liberty of the individual (important as it is) transcends all other considerations?
What if it is through competition alone that we find the ultimate expression of our
humanity?
The challenge facing us today is to make a choice about which alternative we want.
Do we want a society of citizens in which something like the virtues of justice and
benevolence make sense? Or do we want the enterprise association in which each
of us is little more than a purveyor or consumer of commodities? The latter
consigns us to a place where the exercise of virtue will seem an unattainable
luxury, where no person can afford to display moral courage.

Our view is that banks have a great capacity to do well while making a legitimate
profit. They hold the keys to a bridge across which so many of us must pass if our
dreams and aspirations are to become a reality. But few of us will cross a structure
in which trust is wanting. In such circumstances banks and society suffer alike.
That is one good reason for taking seriously the need to eschew fancy dressing in
favor of the simple habit of trust.

Regulation and Self-Regulation

Recent research has begun exploring the complex process of self-regulation, an

important feature in cognitive and somatic behavior therapies. Many interrelating
factors appear to govern self-regulation, with no single factor responsible for its
success or failure. The ability to self-regulate may have advantages in the course of
an individual's mental life, especially within the sporting context. For example,
Vealey, Hayashi, Garner-Holman, and Giacobbi (1998) developed a questionnaire
over a series of experimental trials that examined sources of sport confidence in
335 college athletes. Nine sources of sport confidence were identified among the
athletes that were split into three broad domains (achievement, self-regulation and
climate). The athletes rated, first, achievement (includes self-mastery and
demonstration of ability), second, self-regulation (includes physical/mental
preparation and physical presentation), and third, climate (includes social support,
coaches' leadership, vicarious experience, environmental comfort and situational
favorableness) in order of perceived priority as the most important sources of
improving sport confidence.

The financial role of self- regulating:

One of the most controversial issues regarding financial markets is how do they
regulate themselves? The financial markets have a unique system of regulation; it
is a mixture of law, self regulation and customs. The way the financial markets
make money is all based on the disclosure of information and how this affects the
supply and demand for shares traded on the stock exchange. Often the stock
exchanges around the world are owned by the very stockbrokers who compete
against each other. Several instances have led to successive bouts of self
regulation.

Basic Features of Financial Self-Regulation

Spontaneous self-policing arrangements can be found in the history of international

trade and commercial law, public security, maintenance of public services, and
commercial bank clearinghouses. Self-policing arrangements may develop within
financial communities as well (Goodhart 1988). In some cases, they evolve into
full-fledged self-regulatory organizations (SROs), with internal statutory rules;
dedicated financial resources; formal structures involving shareholders, managers,
and employees; codes of conduct; and oversight procedures (Glaessner 1993).
SROs could involve payments and securities settlement systems, interbank deposit
markets, securities trading and stock exchanges, securities lending and
clearinghouse services, deposit insurance, or credit information-sharing systems.
SRO responsibilities could encompass:

Regulation of Market Transactions

Self-regulation of market transactions ensures that they are executed and
completed by each member according to pre-agreed rules and modalities.

Regulation of Market Participants

Regulation of market participants ensures that members joining in the SRO have
an adequate level of reputational capital and that they maintain it over time.

Dispute Resolution and Enforcement Actions

The efficiency of dispute resolution and adjudication processes is crucial for the
success of the SROs.

Pre-Commitment of Resources
Incentives in financial self-regulation—especially for inter-bank payment and
settlement systems—can be strengthened by members agreeing to individually pre-
commit resources that would be mobilized in the event of one or more members
running into illiquidity or insolvency problems.

Self-regulatory organization

A self-regulatory organization (SRO) is an organization that exercises some degree

of regulatory authority over an industry or profession. The regulatory authority
could be applied in addition to some form of government regulation, or it could fill
the vacuum of an absence of government oversight and regulation. The ability of
an SRO to exercise regulatory authority does not necessarily derive from a grant of
authority from the government. The SEC delegates authority to the National
Association of Securities Dealers (the NASD) and to the national stock exchanges
(e.g., the NYSE) to enforce certain industry standards and requirements related to
securities trading and brokerage

Because of the prominence of the SROs in the securities industry, the term SRO is
often used too narrowly to describe an organization authorized by statute or
government agency to exercise control over a certain aspect of the industry.

ETHICAL & QUESTIONABLE PRACTICE

Ever since 1811, when stock exchanges were allowed to sell shares in businesses,
the stock exchanges across the world have been involved in several ethical issue
debates. Some of the major ethical issues have included the vast amounts of money
involved in the share transactions themselves. Take the classic case of the Barings
Bank stock broker of the mid 1990's, one person was amazingly un-monitored,
eventually generated such excessive losses that he actually made the bank become
bankrupt!, with the resulting loss of income for several hundred employees and the
lost investments for several thousand investors.

As the markets are owned by stockbroker firms selling shares for businesses, the
use of insider information to communicate business information to allow for
greater profits from trading shares, was seen as being a very un-savoury side to the
stock exchange. Stockbrokers were renowned for paying for business information
during the 1970-1980's although attempts have been made to eradicate it; it will
none the less remain within the stock exchange system.
When one stock market losses vast amounts of money in share values, there
appears to be a domino effect in other stock exchanges. National
governments/central banks through exchange rate transactions invest heavily to
maintain the parity between the stock exchanges to prevent a global collapse.

The first major global collapse can be traced back as far as the 1920's during the
Wall Street Crash, this resulted in a severe depression in America, the collapses of
the 1980's and late 1990's have created havoc on the global economy.

The most worrying aspect of the stock exchange is the power they now wield on
the world at large. Shares are traded solely on the basis of generating larger profits,
little regard seems to be given to the lives and families of employees whose
business trades on the stock exchange, low share value ratings can cripple and
bankrupt companies.

The closer integration of stock exchanges on a global computer network will only
add to the domino effect only allowing for the possibility of total economic
breakdown.

Businesses in a capitalist system have become more concerned about how they
maintain share values to generate greater capital investment, yet at the same time
increase dividend payments. This in recent times has meant trying to slash
employee levels whilst maintaining productive output; this is often phrased as
business ethics.

These issues are always bought into discussions about the ethics and power of
stock exchanges.

South Sea Bubble

The first major ethical case to affect the London Stock Exchange was known as the
'South Sea Bubble‘. The south sea company offered shares an impractical and
fraudulent manner. Shares were sold on a partly paid basis, this meant people were
able to buy a lot more shares than they were normally able to. The result was that
excessive amounts of shares were sold in the south sea company. People were
buying the shares on the premise of gaining initial dividends and selling the shares
onto other people who would then have to pay the outstanding balances on the
shares.

As a result of this there was a big crash in the value of all shares on the stock
exchange, lots of people lost money in the crash. Parliament implemented the
Bubble Act of 1720 as well as the Fraudulent Act of the South Seas Company. The
act was the first major regulation of the stock exchange. The Acts made the stock
exchange sell shares for a few selected companies only.