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CHAPTER 1: INTRODUCTION

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."

It would be an understatement to say that the discipline of finance has not been strongly
associated with ethics; if anything, the two areas have been opposed to each other as
mutually exclusive. Even where such an opposition is not maintained, it remains true that
the ethics of finance is underdeveloped compared to the fields of business ethics or
professional ethics. Most financiers have not had a strong ethical formation, whereas
ethicists lack an understanding of the technicalities of financial management, and thus the
situation perpetuates itself. In recent years, however, following a series of stockmarket
crashes, bank scandals and the present general financial instability, there is a renewed
interest in the interface between ethics and finance. Finance Ethics has thus arrived at an
auspicious time, and it merits the attention that it should get as a result. Its central aim is
to show that finance theory, with its assumption of self-interested opportunism and
maximisation of wealth on the part of every agent, cannot explain what really happens in
financial systems. Further, taught in a fundamentalist and uncritical way in business
schools, the ideology behind finance theory leads to the distortion of agents' behaviour in
practice, and the undermining of the proper functioning of a healthy financial system.

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In the globalised world of finance today, where businesses are dealing with each other
often without any personal contact, the need for enforceable contracts is crucial if the
whole system is not to fail. Furthermore, the problem of enforcing contracts is not purely
external to the business. Firms try to create confidence in what they are doing by sending
out "signals" which may or may not convince the market that they are trustworthy.
"Good" firms need to send out "signals" that cannot be mimicked by "bad" firms if they
are to be effective. If giving such a signal is not too costly, the good firm that gives it
creates a "separating equilibrium" in which it is clear who is who to outside agents.
However, such signals do have some cost, and this reduces the efficiency of the good
firm. Again, at best we can have a "second-best" outcome, with a "residual loss" due to
the contractual enforcement problem between agents. It is important to realise here that
we are not dealing with a redistribution of income from principal to agent, but with an
absolute loss from which no-one gains.

Lack of information, or "information asymmetry" can make it difficult for principals to


know in advance whether they can trust agents, and "moral hazard" describes the
situation where it is unsure whether agents will honour or abuse the trust put in them. In
both cases, proponents of finance theory would argue that firms could build a
"reputation" for being trustworthy, consistent with the opportunistic and maximising
assumptions of the finance paradigm. Yet, we still hear of financial scandals, even among
the most respectable banks and financial agencies. Furthermore, firms like Salomon
brothers that were the subject of a serious fraud soon seem to bounce back into action
after a short period of re-organisation and "knocking heads together."

1.1 ETHICS IN ORGANIZATION

From debates over drug-testing to analyses of scandals on Wall Street, attention to ethics
in business organizations has never been greater. Yet, much of the attention given to
ethics in the workplace overlooks some critical aspects of organizational ethics. When
talking about ethics in organizations, one has to be aware that there are two ways of
approaching the subject--the "individualistic approach" and what might be called the
"communal approach." Each approach incorporates a different view of moral

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responsibility and a different view of the kinds of ethical principles that should be used to
resolve ethical problems.

More often than not, discussions about ethics in organizations reflect only the
"individualistic approach" to moral responsibility. According to this approach, every
person in an organization is morally responsible for his or her own behavior, and any
efforts to change that behavior should focus on the individual. But there is another way of
understanding responsibility, which is reflected in the "communal approach." Here
individuals are viewed not in isolation, but as members of communities that are partially
responsible for the behavior of their members. So, to understand and change an
individual's behavior we need to understand and try to change the communities to which
they belong. Any adequate understanding of, and effective solutions to, ethical problems
arising in organizations requires that we take both approaches into account. Recent
changes in the way we approach the "problem of the alcoholic" serve as a good example
of the interdependence of individual and communal approaches to problems. Not so long
ago, many people viewed an alcoholic as an individual with problems. Treatment focused
on helping the individual deal with his or her problem. Today, however, the alcoholic is
often seen as part of a dysfunctional family system that reinforces alcoholic behavior. In
many cases, the behavior of the alcoholic requires that we change the entire family
situation.

These two approaches also lead to different ways of evaluating moral behavior. Once
again, most discussions of ethical issues in the workplace take an individualistic
approach. They focus on promoting the good of the individual: individual rights, such as
the right to freedom of expression or the right to privacy, are held paramount. The
communal approach, on the other hand, would have us focus on the common good,
enjoining us to consider ways in which actions or policies promote or prohibit social
justice or ways in which they bring harm or benefits to the entire community.

When we draw upon the insights of both approaches we increase our understanding of the
ethical values at stake in moral issues and increase the options available to us for
resolving these issues. The debate over drug-testing, for example, is often confined to an

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approach that focuses on individual rights. Advocates of drug-testing argue that every
employer has a right to run the workplace as he or she so chooses, while opponents of
drug-testing argue that drug-testing violates the employee's right to privacy and due
process. By ignoring the communal aspects of drug abuse, both sides neglect some
possible solutions to the problem of drug use in the workplace. The communal approach
would ask us to consider questions which look beyond the interests of the individual to
the interests of the community: What kinds of drug policies will promote the good of the
community, the good of both the employer and the employee?

Using the two approaches to dealing with ethical problems in organizations will often
result in a greater understanding of these problems. There are times, however, when our
willingness to consider both the good of the individual and the good of the community
leaves us in a dilemma, and we are forced to choose between competing moral claims.
Affirmative Action Programs, for example, bring concerns over individual justice into
conflict with concerns over social justice. When women and minorities are given
preferential treatment over white males, individuals are not treated equally, which is
unjust. On the other hand, when we consider what these programs are trying to
accomplish, a more just society, and also acknowledge that minorities and women
continue to be shut out of positions, (especially in top management), then these programs
are, in fact, indispensable for achieving social justice. Dropping preferential treatment
programs might put an end to the injustice of treating individuals unequally, but to do so
would maintain an unjust society. In this case, many argue that a communal approach,
which stresses the common good, should take moral priority over the good of the
individual. When facing such dilemmas, the weights we assign to certain values will
sometimes lead us to choose those organizational policies or actions that will promote the
common good. At other times, our values will lead us to choose those policies or actions
that will protect the interests and rights of the individual. But perhaps the greatest
challenge in discussions of ethics in organizations is to find ways in which organizations
can be designed to promote the interests of both.

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1.2 ETHICS IN FINANCE

Ethics in Finance is a ground-breaking work in the emerging field of finance ethics.


Beginning with examples of the scandals that have shaken public confidence in the ethics
of Wall Street, this book explains the need for ethics in the personal conduct of finance
professionals and the operation of financial markets and institutions.

 Provides a comprehensive overview of the ethical issues in finance.


 The discussion of ethical issues is framed in terms familiar to people in finance.
 Focus is on practical issues that confront people in all areas of finance and that arise
in the developing government and industry regulation.
 Among the many sources are court cases, regulatory actions, and industry reports.
 The book contains an in-depth examination of the firm as a nexus of contracts and
shareholder wealth maximization as the objective of the firm.
Association for Investment Management and Research
The traditional approach to ethics is one of rules, guidelines, and the perception of ethics
as a constraint to profit maximization.
Business professionals are perceived as “moral schizophrenics”— ethical in their
personal lives but unethical in business because being ethical interferes with being
profitable. An alternative view of ethics is the agent-based approach in which being
ethical is the goal, not the constraint.
The agent-based approach is derived from virtue-ethics theory in which “virtue” is the
ability to maintain a balance between two extremes. Virtue ethics has four basic
attributes. First, virtue ethics is concerned with an individual’s character and motivations
and with the maximization of internal goods over external goods.
Second, it emphasizes the importance of an ethical community.
Third, it rejects rules as the means to achieve an ethical environment in favor of broad
guidelines and reasonable moral judgment.
And, fourth, virtue ethics depends on the existence of ethical mentors who, by being
ethical themselves, teach and nurture ethical behavior in others.

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CODE OF ETHICS FOR SENIOR OFFICERS AND FINANCE ASSOCIATES

In my role as a Senior Officer or Finance Associate at Ecolab, I have adhered to and


advocated to the best of my knowledge and ability the following principles and
responsibilities governing professional conduct and ethics:

1. Act with honesty and integrity, avoiding actual or apparent conflicts of interest in
personal and professional relationships. A "conflict of interest" exists when an
individual's private interests interfere or conflict in any way (or even appear to
interfere or conflict) with the interests of the Company.

2. Provide information that is full, fair, accurate, complete, objective, relevant,


timely and understandable, including in and for reports and documents that the
Company files with, or submits to, the SEC and other public communications
made by the Company.

3. Comply with all applicable laws, rules and regulations of federal, state and local
governments, and other appropriate private and public regulatory agencies.

4. Act in good faith, responsibly, with due care, competence and diligence, without
misrepresenting material facts or allowing my independent judgement to be
subordinated.

5. Respect the confidentiality of information acquired in the course of business


except when authorized or otherwise legally obligated to disclose the information.

6. Proactively promote ethical behavior among my associates at the Company and as


a responsible partner with industry peers and associates.

7. Maintain control over and responsibly manage all assets and resources employed
or entrusted to me by Ecolab.

8. Adhere to and promote this Code of Ethics.

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CHAPTER 2: DEFINING ETHICS AND WHAT IS
ETHICAL
To many professionals, the topic of ethics seems to be something esoteric, far away from
the reality of their work life and the situations they encounter day by day (Trevino and
Nelson 2007). Thus, relevant questions in this monograph are the following: What does
"ethics" actually mean? Why should ethical decision making in the finance and
investment industry be looked at not only from an abstract, philosophical viewpoint but
also from a psychological viewpoint? To answer these questions, this chapter defines
ethics, lists the challenges to ethics inherent to the professional field of finance and
investment, and explains the nature and limitations of three fundamentally different
philosophical approaches in judging the ethics of investment professionals.

2.1 ETHICS
Ethics can generally be understood as "rules of behavior based on beliefs about how
things should be" (De Mott 2001). Abstract definitions of ethics range from "a set of
moral principles or values" to "the principles, norms, and standards of conduct governing
an individual or group" (Trevino and Nelson 2007, p. 13). The field of ethics in the
investment industry thus is the study of situations and decisions in the industry that
address moral issues of right and wrong.
Determining whether something is right or wrong from an ethical viewpoint differs
from analyzing it from a legal viewpoint. Although laws generally attempt to codify
ethical considerations into specific rules and explicit regulations, ethics and the law are
not the same (Crane and Matten 2004). Many actions that are not explicitly prevented by
the law may not be considered ethical (consider an investment bank executive allowing
his girlfriend to use the corporate jet for personal travel). As Jennings (2005) noted,
although finance professionals suffer from a dependency on laws and rules, they are
myopic when it comes to ethics.
In fiscal year 2006 (ending 30 September 2006), the investor assistance staff at the
U.S. Securities and Exchange Commission (SEC), the federal authority regulating the

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securities industry, received 20,663 complaints. The 10 most common complaints
involved (1) advance-fee fraud, (2) unwanted e-mails or faxes, (3) manipulation of
securities, prices, or markets, (4) transfer of accounts, (5) errors or omissions in account
records, (6) problems with redemption, liquidation, or closing accounts, (7) delivery of
funds or proceeds, (8) short selling, (9) difficulties in accessing accounts, and (10)
problems with delivery of securities (SEC 2006).
These complaints indicate that many of the ethical issues in the investment industry
involve questions that are addressed by such standards as the CFA Institute Code of
Ethics and Standards of Professional Conduct (see CFA Institute 2005). For example,
according to these standards, unethical behavior of financial analysts lies in making
recommendations that are not based on diligence and thoroughness, composing research
to support specified conclusions, leaking inside information, giving unfair preferential
treatment to certain clients, plagiarizing, not telling the truth about a company's
(expected) performance, front running (i.e., using new material information to trade for
one's own accounts before trading for clients' accounts), and hiding from their employer
or customer a conflict of interest (see Veit and Murphy 1996). Analysts may also use
their insider knowledge for personal gain or incorrectly handle conflicts of interest
between the "research" and the "underwriter" parts of investment companies (Jennings
2005). The insufficient management of these conflicts of interest is paid for dearly by
customers and also by the investment public who trusts those analysts employed by
investment banks: When markets perform poorly, independent investment analysis and
advice are likely to be significantly better than the investment analysis and advice offered
by in-house analysts who work for banks (Barber, Lehavy, McNichols, and Trueman
2006; Simon 2004).
Ethical issues in the investment industry arise not only between analyst and investor
but also in various other relationships—between competitors, between employer and
employee, between superior and subordinate, between adviser and client, and between an
organization and its representative. Moreover, in addition to unethical practices that are
specific to the finance and investment industry (Duska 2005), unethical behavior among
professionals may include non-industry-specific behavior, such as the following: In a
survey sent to several thousand workers in the United States, reported unethical actions

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arising from work pressure included such items as covered-up incidents, deceiving
customers, putting inappropriate pressure on others, falsifying numbers, lying to
superiors, withholding information, misusing company property, discriminating against
coworkers, bribing, abusing expense accounts, leaking proprietary information, and
accepting inappropriate gifts (Petry, Mujica, and Vickery 1998).
What is considered ethical misconduct in the investment industry may sometimes be
an obvious and crystal clear violation of a value. Former SEC Chairman William
Donaldson's summary of allegations against financial analyst Jack Grub-man included
the following:
[He] issued several fraudulent research reports that contained misstatements and
omissions of material facts about the companies, contained recommendations
contrary to his actual views regarding the companies, overlooked or minimized the
risk of investing in these companies, and predicted substantial growth in the
companies' revenues and earnings without a reasonable basis. The complaint against
Grubman further alleges that he issued numerous research reports that were not based
on principles of fair dealing and good faith, did not provide a sound basis for
evaluating facts regarding the subject companies, and contained exaggerated or
unwarranted claims about those companies. (Donaldson 2003)
As Jennings (2005) noted, "No one within the field looks at Jack Grubman . . ., the
fee structures, the compensation systems, and the conflicts and frets, 'These were very
nuanced ethical issues. I never would have seen those coming.' "
At other times, however, ethical dilemmas in the industry involve a true tension
between important values—a conflict of "right versus right" (Kidder 1995, p. 13), a clash
between contradictory duties (Newsome 2005). Imagine, for example, a young analyst
deciding whether she should bypass the organizational line of command and report the
seemingly questionable conduct of her immediate supervisor to top management. This
analyst experiences tension between two goods: the welfare of the organization and her
respect for her supervisor (see Fang 2006).
Much academic ink has beesn used to define ethics, and although all the abstract
definitions shed valuable light on the nature of ethics, a definite and once-and-for-always
valid definition of ethics is impossible. Such a definition may not even be necessary for

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the purposes of this monograph (i.e., to provide insights into the psychological dynamics
involved in ethical and unethical behavior). Nevertheless, although all finance
professionals have at least an implicit understanding of what ethics is about, it is
important to stress that a genuine understanding of ethics in the finance and investment
industry treats ethics as more than simply "avoiding wrongdoing."
Thus, ethics should be understood as not being limited to a set of prohibitive rules; it
goes far beyond a mere catalog of do's and don'ts. The best understanding is to view the
ethics of finance professionals as a value worth practicing as a goal in itself, a necessary
condition of personal and professional excellence (Dobson 1997; Pritchard 1992). From
this perspective, ethics in finance and investment is a driving force of a career that is well
lived (Solomon 1999).
Normative, Descriptive, and Prescriptive Approaches to Ethics
When people talk and write about ethics in the finance and investment industry, they
approach the topic in a variety of ways and address different realms of ethics. Usually,
their dealing with ethics takes one of three main directions: (1) what investment
professionals should do, (2) what they actually do, or (3) how finance and investment
professionals can be helped to get from what they actually do to what they should do.
1. Normative ethics. What should finance and investment professionals do? As the name
implies, normative ethics aims at establishing norms and guidelines for professionals
regarding how they should behave. This approach to ethics is inherent in, for
example, the ethical theories of moral philosophy, theology, and definitions of
professional norms, standards, and acceptable behavior for a professional field. Thus,
a normative approach to ethics in finance and investments defines what is ethical in
this profession. It tells practitioners how investment professionals should act to be
ethical, which behavior should be considered ethical, and which behavior should not
(Crane and Matten 2004). The guidelines and rules laid out in the CFA Institute Code
of Ethics and Standards of Professional Conduct (CFA Institute 2005) address ethics
in a normative way by establishing behavioral guidelines to which members must
adhere.
2. Descriptive ethics. What do investment professionals actually do? Descriptive ethics
aims at describing not how people should behave but how they actually do behave.

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And descriptive ethics attempts to explain and predict the (un)eth-ical behavior of
people in real-life situations (O'Fallon and Butterfield 2005). Psychological research
conducted in controlled laboratory studies and real-world settings of professional
decision makers offers a systematic and comprehensive basis for descriptive ethics in
finance and investing. Only this psychological and descriptive approach allows us to
understand when and why people and organizations in the investment industry
engage in ethical behavior and when and why they do not (Crane and Matten 2004).
3. Prescriptive ethics. How can finance and investment professionals be helped to get
from what they actually do to what they should do? Based on descriptive insights
about the factors influencing actual ethical decision making, the prescriptive
approach to ethics aims at helping people and organizations toward ethical decision
making by giving advice about how to create environments that foster ethical
decisions and how to improve the ethical component of decisions. The two main
questions addressed by prescriptive ethics are the following: How can we create
organizations that foster ethical behavior? How can we train professionals to readily
perceive the ethical dimensions of their own behavior and to act ethically? Thus,
prescriptive ethics suggests tools that assist people in making the prescribed decisions
(Trevino and Nelson 2007).
This overview of the normative, descriptive, and prescriptive approaches to ethics
reveals that the aim of the present monograph is not normative in nature. Unlike the Code
of Ethics and Standards of Professional Conduct, this monograph is not intended to tell
investment professionals how they should decide and behave. The monograph is a
descriptive summary of important insights into how investment professionals actually
make decisions, and it reports research findings about the actual factors underlying
(un)ethical decision making. Often, prescriptive conclusions and advice about how to
improve the ethical dimension in decision making can be easily inferred from these
descriptive insights; rarely will such advice be explicitly offered.

2.2 NORMATIVE THEORIES


However, as the saying goes, it is nice to know classical music before playing jazz. Thus,
to provide a fuller understanding of the field of ethics in the finance and investment

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industry, this section provides a short (and necessarily superficial) overview of three of
the most important normative theories in ethics—describing not how people actually
make decisions but ideals of ethical decision making. These theories have been
developed over centuries and constitute the major normative approaches to ethical
decision making even today. The differences in what they define as ethics are largely
based on where they place the focus in judging what is ethical—on the consequences of
decisions, on universal duties and abstract principles, or on the personal character and
virtue of the decision maker. The following overview also shows that when we face the
complexities of situations and issues in the investment industry, no single approach
guarantees perfect and simple solutions to ethical decision making (Trevino and Nelson
2007).

Judging Ethics by Consequences. To judge whether something is ethical,


consequentialist theories strictly emphasize the consequences of the decision. Of course,
the consequences of actions matter in ethical decision making. In fact, economists and
finance professionals are highly familiar with this approach to decision making. When
they invest money, they look at the utility of financial decisions' outcomes and choose the
course of action that results in the highest utility (e.g., the financial product or strategy
that promises the highest risk-adjusted profit).
Only decision outcomes matter in consequentialist theories: The most ethical decision
results in the greatest benefits (to society or to all stakeholders); an unethical decision
results in disadvantages and harm (Trevino and Nelson 2007). The ethical utilitarianism
reflected in consequentialist theories aims at maximizingthe utility of a decision's
outcome to society; an ethical decision simultaneously maximizes benefits and minimizes
the harms to those affected by the decision. Thus, these theories of ethical behavior are
ends based (Kidder 1995).
Although the utilitarian approach is valuable in thinking about the ethics of a certain
decision, efforts to base decisions exclusively on this approach quickly face practical
limitations. Typically, decision makers do not have all the information necessary to
foresee all consequences for everyone affected by a decision, and gathering this
information may even be impossible. For example, Jeffrey Skilling, the president and
chief executive officer of Enron Corporation, in effect, granted Chief Financial Officer

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Andrew Fastow a waiver from the conflict-of-interest rules in the company's code of
ethics by allowing Fastow to establish a "special purpose entity" to reduce the company's
fees at investment banks. At the time when Skilling agreed to this procedure, he may not
have anticipated the destructive consequences of this conflict of interest but may have,
instead, focused on the possible benefit of the reduced fees to Enron and the company's
shareholders (Eichenwald 2005).
Another limitation of this approach is that consequentialist thinking can be used to
justify evil by way of a calculated "greater good"—for example, when the continued sale
of a dangerous product is known to result in a small number of predictable deaths, as in
the case of the Ford Pinto. Despite media reports about incidents of Pintos burning after
rear-end collisions and passengers dying from these fires, Ford Motor Company
continued to produce and sell the car without modifications to the dangerous fuel tank
that had been proven to easily rupture and catch fire. Ford knew that its path would lead
to additional victims of fire after accidents but, based on a cost-benefit analysis, decided
that the profit of the company outweighed the cost of anticipated casualties (Maclagan
1998). This example shows that using a strictly consequentialist approach can easily lead
to a solution that sacrifices the interests of minorities and individuals in order to achieve
the greatest good for the greatest number of people (Trevino and Nelson 2007).

Judging Ethics by Universal Duties and Principles. A second group of ethical


theories focuses on universally valid duties and principles. These approaches emphasize
the binding nature that abstract principles have on a decision regardless of the
consequences of the decision. These philosophical approaches to ethics are labeled as
deontological, which comes from the Greek word deon for duty or obligation. What is
most important in deontological theories of ethics is adherence of the decision makers to
principles—such as "keep your promises," "treat everybody fairly," and "always tell the
truth" (Trevino and Nelson 2007). In other words, deontological ethics answers the
question of how finance and investment professionals should approach ethical issues by
having them step out of the specific situation and use one or more universal principles to
make the decision (Dobson 1997). Thus, these theories of ethical behavior are rule based
(Kidder 1995).

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Deontological thinking is primarily associated with the 18th century German
philosopher Immanuel Kant's "categorical imperative." According to the categorical
imperative, decision makers in a given situation should act according to the way in which
they would like everybody to act in that situation. In Kant's words, "I ought never to act
except in such a way that I can also will that my maxim should become a universal law"
(Kidder 1995, p. 158). A well-known example of a deontological principle is the Golden
Rule: "Do unto others as you would have them do unto you." Thus, finance professionals
should ask themselves whether they would want the principle according to which they are
acting to become a general standard, valid for everybody.
Difficulties when taking a deontological approach to decision making arise when two
valid principles are opposed, as is the case in many ethical dilemmas. For example, the
employees of an investment firm may find themselves caught in the dilemma between
loyalty to their company's interests and truthfulness vis-a-vis their investment clientele. A
purely deontological approach may not be able to solve the question of which side takes
precedence over the other. Moreover, in many examples, deontological approaches to
ethical decision making seriously conflict with consequentialist arguments, as in the
example of the 1940s German homeowner who always tells the truth and informs the
Gestapo about the Jewish family hiding in the attic (Trevino and Nelson 2007).

Judging Ethics by Personal Character and Virtue. Virtue ethics (or theories of
virtue) emphasizes the character, motivation, and intention of the decision maker. The
understanding of ethics in virtue ethics represents a comprehensive approach, not a
specific approach, because it moves beyond the examination of single isolated issues or
situations. It looks at ethics from an agent-based perspective, not an action-based
perspective; it addresses characteristics of the decision maker's personality rather than
particular actions (as in the rules and guidelines for actions in deontological theories) or
consequences of actions (as in consequentialist theories) (Dobson 1997).
Ethical theories of virtue often refer to Aristotle, who described in Nicomachean
Ethics the human pursuit of happiness through moral excellence. As the name implies,
virtue ethics considers character to be important, but virtue ethics also stresses the need
for a community that cultivates the virtues. In virtue ethics, moral judgment is seen as

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something that goes beyond the following of rules. Instead of rules, ethical role models
play an important part in developing ethical judgment
(Dobson 1997).
An example of such a role model is Warren Buffett, who was viewed by many as the
embodiment of integrity when, after the U.S. Treasury auction scandal at Salomon
Brothers, he took the helm of the firm in 1991. Buffett immediately stressed the
importance of setting an example from the top, and he clarified that he would not tolerate
activities "that fall just within the rules" (Hylton 1991).
Thus, in virtue theories, the question, what should I do? is embedded in the question,
what sort of person should I be? (Maclagan 1998).
Until recently, virtue ethics was not considered very important in academic efforts to
understand ethics in professional business settings because of the tension between its
focus on the person and the predominantly problem-oriented thinking of managers. Going
beyond specific ethical decisions has gained in importance, however, as skepticism about
many management techniques and theories has grown
(Maclagan 1998).

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CHAPTER 3: LAW, ETHICS, AND INTERNATIONAL
FINANCE

3.1 INTRODUCTION
Cross-border financial flows can have dramatic effects on the recipients of the money—
for good or for ill. This is particularly true in countries whose economies and capital
markets are underdeveloped. A relatively small inflow of foreign capital into such a
country can inflate valuations on a local stock exchange or allow the government to
distribute pre-election largesse in the form of subsidies, tax breaks, spending on public
works projects, and so forth. A sudden outflow of that capital, however, can have
disagreeable consequences of an equal and opposite magnitude.
Ethical questions about who should receive cross-border financing, in what amounts, for
what purposes, and on what conditions have long engaged the attention of international
financial institutions such as the World Bank, the International Monetary Fund, and the
regional development banks. There may even still be a few commercial lenders holding
to the view that a private creditor should concern itself solely with the profitability of a
transaction and the likelihood that the debt will be repaid, to the exclusion of all other
ancillary issues, but these probably constitute a dwindling minority. Like it or not, loans
that are susceptible to challenge on grounds of illegitimacy or recklessness run a higher
risk of non-payment. So, whether viewed under the light of ethics-morality or profit-loss,
the issues cannot be avoided.
What, if anything, does the law add to this discussion of ethics and international finance?
The law and the machinery of justice are certainly ubiquitous elements in the lending
process. After all, cross-border credits are invariably evidenced by contracts of one kind
or another that contemplate enforcement in a national court. Specifically, are the ethical
considerations raised by cross-border loans exclusively matters to be taken into account
before the credits are extended, or are they also relevant to the interpretation and
enforcement of the legal agreements that eventually evidence the credits?

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3.2 THE RULES
Parties entering into a commercial contract want predictability in its interpretation and
enforcement. The outcome produced by the application of the governing law in any
particular dispute may be far less important to the parties than the fact that the outcome
can be anticipated in advance of signing the contract. why? Because if the predictable
outcome is commercially unacceptable to one or both of the parties, they are free—before
they have signed the agreement—to adjust its terms to avoid that result, to switch the
chosen governing law if a switch solves the problem, or, as a final resort, to scrap the deal
altogether. But what commercial parties find intolerable is the prospect of locking
themselves into a contractual arrangement that may subsequently be interpreted or
enforced in a manner inconsistent with their presigning intentions.
The ability of a legal regime to deliver a predictable outcome is one of the major reasons
why contractual counterparties will choose that regime as the governing law of their
contract. This is particularly true in the context of financial transactions. Most lending
arrangements involve starkly asymmetrical performance by the parties: the lender's
obligations are heavily front-loaded (they lend the money), while most of the borrower's
obligations are performed thereafter (they must pay the money back over time). In
asymmetrical contracts of this type, the party that must perform first—here, the lender—
has an especially keen interest in knowing that it can enforce the subsequent performance
of its counterparty or obtain an award of fully compensatory damages if that performance
is not forthcoming.
Common-law legal systems, with the importance they attach to judicial precedents, have
a natural advantage in this regard. The accumulated weight of those precedents both
presage and constrain how the judiciary will interpret the provisions of commercial
agreements. Judges in these systems are not free to reach wholly imaginative or
idiosyncratic conclusions about what contractual provisions mean or how they should be
enforced.

17
3.3 THE EMOLLIENTS
But even in the strictest common-law systems, this goal of sharp predictability is padded
at the edges to safeguard against results that would strike most people as unfair or unjust.
over the centuries, Anglo American jurisprudence has leavened the application of the
rules governing the strict enforcement of contracts with doctrines that permit judges to
reach decisions comporting with their sense of fairness and equity in the circumstances of
a particular case. Giving the judiciary this maneuvering room obviously injects a degree
of subjectivity into the decisionmaking process. To put it bluntly, the more a legal system
tolerates emollient doctrines of this kind in its contract law, the less confident parties can
be that their agreement will be interpreted and enforced by Judge Jones in Courtroom 101
in precisely the same way as it would have been by Judge Brown in the adjoining
Courtroom 102. This fundamental tension has long been visible in the development of
Anglo American contract law. A strong desire for predictable interpretation and
enforcement of commercial agreements has been balanced against a recognition that
judges should not be forced by an unyielding set of rules to hand down judgments that are
repugnant to a sense of fairness and justice.
This tension propelled, for example, the growth of the courts of equity and equity
jurisprudence in England during the fifteenth and sixteenth centuries. The common law
as it then existed may have produced predictable results, but it was increasingly perceived
as ossified, inadequate in the remedies that it offered injured litigants, and frequently
unfair in its harshness and rigidity. The result? A parallel system of courts, the chancery
courts, dispensing equitable relief in a more flexible manner, came into existence. As part
of this equity jurisprudence, judges were free to entertain excuses for the non-
performance of contracts under doctrines such as undue influence, fraud,
misrepresentation, mistake, impossibility or impracticability of performance, unclean
hands, laches, and so forth.
The ability of American judges to widen their peripheral vision in contract cases to take
into account the circumstances surrounding a contract, and not just its black letter, was
significantly boosted in the twentieth century by the recognition of doctrines such as
"unconscionable" contracts and the "good faith and fair dealing" obligations imposed on
all parties to a contract. These concepts are deliberately imprecise. But they invite judges

18
to weigh factors in judicial decisionmaking that might, in other contexts, be described as
ethical, moral, or equitable in nature.
And finally there is the bankruptcy court—that place where any contract can be
suspended, modified, or abrogated as necessary to give a debtor a shot at rehabilitation.
Bankruptcy is thus the ultimate emollient. This too was a product of the twentieth
century. The type of bankruptcy proceeding now referred to in the United States as
Chapter 11 for corporate debtors was only introduced in the 1930s and has gradually been
refined through several legislative amendments over the intervening years.

3.4 FINANCE DIFFERENT


If the development of contract law has gradually accommodated the introduction of
features and institutions like bankruptcy that soften the application of rigid interpretative
rules and admit ethical and equitable considerations into the judicial decisionmaking
process, why should cross-border financial contracts be viewed any differently from
purely domestic financial contracts? In other words, what justification can there be for
expanding or reinterpreting the conventional emollients in a cross-border context?
There are several reasons, among them the absence of a global bankruptcy regime, the
convention that successor sovereigns assume the debts of their predecessors, and the
restricted reach of judicial remedies.

A. No Bankruptcy Regime
This moderating influence is frequently absent in cross-border financial disputes.
sovereign debtors completely lack this element of leverage over their creditors. There is
no bankruptcy regime for a sovereign borrower. sovereigns are uniquely vulnerable to
hostile creditor legal actions; there is no possibility of an "automatic stay" of such
actions, much less an involuntary "cram down" of a plan of reorganization.
In the corporate context, the shoe is often on the other foot. A corporate debtor located in
a jurisdiction that lacks a fair and functioning bankruptcy regime has more leverage over
its creditors than does its U.S.-based counterpart. Putting a corporate debtor into
involuntary bankruptcy in such a country is frequently so appalling a prospect for the
creditor that any negotiated workout is preferable to the bankruptcy option.

19
B. Public International Law

Cross-border financial contracts can sometimes be affected by public international legal


principles that have no correlatives in municipal law. The best example is the public
international law doctrine of state or governmental succession to debt obligations
incurred by prior regimes in the debtor country. It is a strict doctrine around which few
emollient principles have ever coalesced. For example, interpreted strictly—and it usually
is interpreted strictly—this doctrine forces sovereign borrowers to assume the
responsibility for debts incurred by former despots for their own personal use.

C. Limited Scope of Judicial Remedies

Private parties usually have little choice but to submit their cross-border financial
contracts, even with sovereign borrowers, to the municipal laws and the municipal courts
of one country or another. There is no truly international law of contracts and no
transnational judicial body to adjudicate contract disputes. The remedies available to a
judge sitting in such a municipal court, however, are limited and parochial. The cause of
action is money due but not paid on a debt instrument. The remedy is typically an award
of monetary damages.

The evolution of Anglo American contract law has thus been shaped by a desire for clear,
predictable rules of contract interpretation and enforcement, on the one side, and a
perceived need for emollient doctrines or institutions by which considerations of fairness,
reasonableness, and equity are admitted into the judicial decisionmaking process, on the
other.
The trick, of course, is finding a way to relax the strict legal rule to avoid the morally
repugnant result, without abandoning altogether the principle that sovereign-debt
contracts are intended to be legally binding undertakings.

20
CHAPTER 4: ETHICS IN THE FINANCIAL AND
INVESTMENT INDUSTRY
In 1999, before the dot-com bubble burst, the second season of the television series "The
Sopranos" went on the air. In this series, the family, unwilling to miss out on all that dot-
com action, starts pushing the stock of an obscure technology company, Webistics, on
unsuspecting retirees. They use brokers who know that the stock is a "dog" because of the
company's outdated technology:
Broker 1 (talking on the phone with a customer): You know, from what you told me,
Webistics would be perfect for your portfolio. I understand you're on a fixed income,
but with Webistics, you could triple your money in a year. Uh-huh, yeah, 10, 12
months. I really shouldn't be telling you this. The company's Webistics. It's the next
Yahoo! right now. We're really only selling it to preferred clients.
Broker 2 (on the phone with a customer): Yeah, American Forestry, 19 and 1/2, up
3/8s, a very sound company. Well, it depends on whether you wanna go for growth
or value. We got hundreds of mutual funds you can choose from.
Broker 1 (while punching Broker 2): Ahh! You're supposed to push Webistics!
Broker 2: I was giving them alternatives.
Broker 1 : Webistics is our pick of the week!
After the stock price has risen considerably, the family sells out its position in the stock
and cashes in on the profits.
This story paints the nightmare scenario for any investor. The Sopranos are a
fictitious TV family, but the question is whether something like this scenario could
happen in reality. Apparently, it can. In June 2003, in San Diego, newspaper headlines
announced the indictment of eight employees of the brokerage firm Hampton Porter
Investment Bankers. These investment professionals had been involved in a securities
fraud scheme that affected more than 100 investors throughout the United States, with
registered losses of US$5 million.
Through their investment banking deals and from other sources, the investment
bankers allegedly obtained and controlled a large number of shares of certain low-priced
thinly traded "penny stocks." The brokers allegedly received special undisclosed

21
incentive payments to push the sale of these stocks through a variety of high pressure,
deceptive sales tactics. Once customers bought the stocks, raising their prices, the co-
conspirators allegedly sold their shares and reaped huge profits. The indictment further
alleges that the defendants prevented customers from selling their shares of the stocks by
delaying or failing to execute the customers' sell orders (Department of Justice 2003).
This real-life story of what is often called a "pump and dump" ploy depicts one of the
many schemes that was going on at the height of the dot-com boom. One of the traded
shares involved in the fraud could very well have been a "Webistics."
Now, the bubble has burst, accounting and investment fraud scandals have gone
public, large financial firms have collapsed, and top executives have gone to prison.
Fraud schemes, however, such as the one portrayed on "The Sopranos" and implemented
in real life by the Hampton Porter employees, are as prevalent today as they were in
1999, and they seem to be proliferating. Ethical scandals are too numerous to label as
temporary aberrations or samples of abnormal behavior, and they range from petty to
high-profile skullduggery.

4.1 ETHICAL VULNERABILITIES OF THE INVESTMENT


PROFESSIONS
The periodic waves of ethical scandals in the finance and investment industry have been
followed by severe scrutiny and legal reforms Jennings 2005; Weirich and Rouse 2003).
For example, in the bull market of the 1990s, many in-house analysts had strong
incentives to bolster their banks' investment operations. These incentives corrupted the
objectivity of their research and recommendations. As a result of the subsequent public
protest, the settlement between state and federal securities regulators and 10 of the largest
Wall Street firms imposed structural reforms and required disclosure of analysts'
recommendations (see www.oag.state.ny.us/press/ 2002/dec/dec20b_02.html).
During these scandals, professionals in the fields of finance and investment did not
manage their ethical image well in the eyes of the public. Gallup Polls conducted in the
past decade on the perceived ethics of various occupations indicate that "bankers" are
losing status and that "stockbrokers" have repeatedly been rated among the least ethical
professions.

22
Moreover, in the new millennium, after the demise of Enron Corporation,
WorldCom, and Arthur Andersen, the ethical standards of "business executives" have
been rated by many as low or very low (Stevens 2004). Again, a heated debate about
reforming and increasing regulation of the financial and investment industry and U.S.
corporations resulted. In response, the Sarbanes-Oxley Act of 2002 introduced tighter
regulations on corporate governance and financial disclosure
(Newsome 2005).
Having shattered the trust of the public and having attracted the wrath of the
regulators, the investment industry has been forced to question and redefine its ethical
fundamentals. The fact is that a large number of factors inherent in the investment
industry make this professional field vulnerable to ethical breakdown. To begin with,
temptations to profit from unethical behavior are often larger in finance than in any other
field. Although this conclusion seems obvious, it is also easily underrated, as the
following anecdote warns. As the story goes, when Willie Sutton was asked why he
robbed banks, he replied, "Because that's where the money is" (Bernstein 2006).
In addition, the professional barriers to entering the investment industry are limited.
Therefore, the barriers may be crossed by people of a large variety of professional
backgrounds. One result is that achieving a common ethical understanding is difficult
(Caccese 1997).
A look at how scandals and complaints are handled in the medical field, in religious
organizations, and in the military suggests that all professional environments tend to
sanction and internally validate the actions of their practitioners— even when they are
unethical. The self-justifying dynamics involved in this phenomenon may be particularly
pertinent in the area of finance and investment (Bernstein 2006).
Moreover, in recent years, financial and investment activity has grown much more
rapidly than the rest of the economy. This explosive growth has been accompanied by a
great deal of specialization among finance professionals, who work in increasingly
complex organizations. Increased specialization and complexity may dim financial actors'
views of their actions' consequences in a significant way. For example, finance experts
have noticed that technology has isolated their work from the "real economy" and that the
institutions and the culture of the finance and investment sector are now often far away

23
from other areas of the economy. In addition, many of the theoretical models and
paradigms of finance do not encompass the social complexities of the economy, let alone
of society. A case in point: The paradigm of perfect capital markets that governs many
financial models suggests that individual players have no influence on the market. This
lack of influence distances the actors in finance and investment from the consequences of
their actions and allows them to lose sight of their personal responsibility (Bonvin and
Dembinski 2002).
All of these factors show that ethics in the investment profession is not only complex
but also highly vulnerable. These factors correspond to psychological findings on the
conditions that increase the likelihood of people committing harmful and unethical
actions in everyday life. As a field study by noted psychologist Philip Zimbardo has
shown, anonymous environments bring about unethical vandalism. In his study,
Zimbardo placed abandoned cars with license plates removed and hoods raised in two
highly different social environments, Palo Alto, California, and the Bronx, in New York
City. The cars were secretly filmed from some distance away. In the Bronx, it took no
more than 10 minutes for the first vandals to begin their work of destruction, and within 2
days, more than 20 acts of theft or damage had been committed. All but one of these
certainly unethical and often highly destructive acts were committed by adults, many of
them well dressed and driving their own cars. In contrast, no single act of vandalism was
recorded in Palo Alto over the duration of a work week. Instead, when the car was
removed by the experimenters, three residents informed the police that a car was about to
be stolen (Zimbardo 1976).
Zimbardo (2004) explained the differences in these two outcomes as follows:
Any environmental or societal conditions that contribute to making some members of
society feel that they are anonymous—that no one knows or cares who they are, that
no one recognizes their individuality and thus their humanity—makes them potential
assassins and vandals, a danger to my person and my property— and yours. (p. 33)
This explanation brings to mind the picture of global financial markets, where
faceless players across the globe engage in transactions and where the traded commodity
is no more than abstract numbers. Environmental anonymity is a condition of countless

24
transactions in today's financial markets. Thus, the very nature of this professional field is
certain to pose a formidable challenge to ethical behavior.

4.2 ETHICAL PROFESSIONALS INVESTMENT


Another challenge to ethics in the field of finance and investment is revealed by the
question of why professionals in this field should be ethical at all. In many of today's
curricula in the business schools that investment professionals proudly attend, the
objective of rational individuals is wealth maximization. According to the dominant
neoclassical economic perspective, ethics, in this context, functions as a behavioral
constraint (Dobson 1993). This kind of thinking is reflected in, for example, codes of
"ethics" and rules of compliance that aim purely at avoiding the costs that engaging in
unethical behavior would entail for the company. It is also reflected in the focus
ofvarious industry watchdogs on protecting the unsophisticated consumer and
maintaining standards and control systems throughout the industry. Finally, this
understanding of ethics is reflected in investment organizations that define reputation,
integrity, and being ethical not by their intrinsic worth but in materialistic terms, where
these "values" represent no more than another means to the actual end of profit
maximization.
Fortunately, the neoclassical economic view of self-interest is being increasingly
challenged by psychological theories and findings. These findings suggest that people
want to be ethical and have an intrinsic interest in being ethical that does not rest on
extrinsic punishments or other outside factors (Vidaver-Cohen 2001).
Proponents of the economic view of human self-interest often cite Adam Smith, who
famously declared, "It is not from the benevolence of the butcher, the brewer, or the
baker that we expect our dinner but from their regard to their own interest" (Smith 1904).
MacIntyre (1999) asked, however, if we enter the butcher's
shop only to find him on the floor of the shop suffering a heart attack, is it probable that
we would follow in a self-interested way the norms of the market, leave him dying on the
floor, and simply finish our purchase at the butcher next door? No, in this situation, even
the toughest finance pro would probably come to the aid of the butcher and call an

25
ambulance (Bernstein 2006; Dobson 2005). Thus, the maxim that people are only self-
interested is ideologically normative, not a description of
real behavior (Miller 2001).
That ethical values and justice motivate the decisions of economic decision makers
has also been demonstrated by psychologists in the "ultimatum game." This game is
played by two players. The first player's task is to divide €10 between herself and the
other player. For example, she could suggest that both players receive €5 or that she keep
€8 and the other player receive €2. The division is an "ultimatum" because either the
second player accepts and the division is made or the second player refuses and neither
player receives anything. From the viewpoint of economic rationality and self-interest,
the second player should thankfully accept even an offer of 1 cent because from a
viewpoint of egoistic self-interest, 1 cent is better than nothing. Psychologists have
shown, however, that offers far below €5 are usually rejected. Such offers are perceived
to be immoral; they violate basic values ofjustice and fairness. Thus, the ultimatum game
shows that defending these ethical values is more important to players than profit
maximization.
For a better understanding of ethics in the financial and investment industry, the
question of what motivates people—in particular, financial and investment professionals
—to be ethical is crucial. In the present day, fortunately, our knowledge about how to
answer this question is greater than ever before (Dienhart, Moberg, and Duska 2001). To
answer the question, we should remember that throughout the history of philosophy,
ethics has been viewed as a motivation, not as a constraint (Dobson 1993), and this view
is confirmed today by psychology.

26
CHAPTER 5: CASE STUDY

CASE STUDY I : ETHICS AND FINANCIAL SERVICES


A fictional case of a financial investment firm, based in offshore locations for the most
part. It presents the structure and practices of the firm, with some expansion of these
using anecdotes from the recent past. A range of ethical questions are introduced, relating
to financial regulation, and employment practices. Readers are invited to take the
perspective of an external consultant in evaluating and trying to change the ethical
position of the firm.

STELLING MINNIS

In 1947 Alexander Stelling started a stockbroking business in the City of London. Over
the following twenty-five years he built this up into a well-established and well-respected
firm, with a strong client list. In 1972 he entered into a joint venture with two American
entrepreneurs, setting up a small commercial bank. This encountered serious difficulties
and was wound up in 1974, and eventually as a result Stellings was taken over by the
Minnis Group, stockbrokers operating originally in London and New York, but more
latterly based in offshore locations such as Jersey, Cayman and the Isle of Man.
Alec Stelling carried on for another four years as a director before retiring. Minnis
continued to hold the Stelling operation at arms length until 1980, when it merged the
two businesses, and moved its main office to Jersey. In 1992 the Minnis Group itself was
broken up. The old Stelling arm of the Group was divested and taken over as a
management buy-out by a group of established employees. The company was re-named
Stelling Minnis as a means of keeping a link with the history of the firm, and as a way of
holding on to the established customer base.
Stelling Minnis has continued since then as a limited company, majority owned and run
by eight of the original nine managers who
took over the firm in 1992 (and who slightly misleadingly prefer to be called the
partners).

27
It has 177 staff - 124 financial advisors and sales staff, 45 clerical and administrative
support, and the 8 partners. Of the employed staff, 18 have been with the company since
the days of Alec Stelling, and only 12 have joined since 1992. There is a strong 'family'
ethos amongst the longer serving staff, and a high degree of loyalty to the firm - even
when there are differences with the partners.
The company is registered in Jersey and has its main HQ there, though there are also
offices in Grand Cayman, Douglas Isle of Man, London and New York. Nowadays its
clientele come from all around the world.

STRUCTURE

There are three divisions -

Equities - Based at Head Office, but with an office in New York. 105 advisory/sales staff
supported by 15 administrators, and headed up by 2 of the partners, provide advice on
share transactions for a client base of personal investors, mostly these days from the
developing economies and post-communist states.
Fund management - 3 of the partners, supported by 18 administrators, manage portfolios
for a range of small to medium corporate clients, mostly UK, from the office in Douglas
Isle of Man.
Custody and services - Based in Grand Cayman. Provides a range of services, including
custody, company registration and company secretarial, management consultancy, tax,
trade finance and venture capital. Run by the remaining three partners with the assistance
of 19 advisors and 12 administrators. Customers come mainly from the UK and USA.
One of the partners, a lawyer by training, deals with all aspects of complying with
legislation and regulation of the various countries in which the company operates.
Employment policies
All employees are treated as self employed - even though some of them may have
worked for the firm since before its takeover by Minnis. The prime rationale for this is
that it gives the firm much more flexibility than 'having to shoulder the responsibility for
employees; this way each worker is empowered to take responsibility for themselves' as
the Director of HR recently explained. Each employee is encouraged to take a small non-

28
voting equity stake in the company (equivalent to about a month's salary) as a sign of
goodwill. This is structured in such a way that ownership reverts to the partners upon the
employee's resignation from the company. Individuals may also purchase voting shares
on their own behalf, and some more senior staff have substantial holdings. Occasionally
large bonuses to senior management are given as shares or share options.
There has been a concerted effort to operate fair recruitment practices in recent years,
though inevitably the more relaxed approach of the past is still very much in evidence in
the low overall proportion of senior women and members of non-white ethnic groups at
almost all levels. There are no employees who are known to have disabilities.
Staff development needs are identified by managers as part of the review process, and are
therefore very closely linked with business performance. Staff are encouraged to take
responsibility for their own development, and are able to take advantage of a training
voucher scheme, whereby they receive vouchers for a given level of cash to pay for
training. If they choose to take more expensive development programmes, then they are
expected to make up the difference themselves. Most staff have taken advantage of this
policy to become specialists in an aspect of the work of their division.
There is a generous pay and benefits scheme (even by the standards of the financial
services sector) which was set up in outline by Alec Stelling as long ago as 1958. Salaries
are well above national averages. Sales staff have a high basic above which they can earn
up to 20% from commissions. Additional performance bonuses are calculated on a
combination of individual, team and company performance, so that although everyone
partakes of the company's success, those who made most effort get the most reward. In
good years the best sales staff have earned over 100% bonus, and even the most junior
secretary has received up to 25% addition to their salary.
Performance is rigorously measured and monitored. All staff have six monthly reviews
where achievement against targets is assessed and new targets for the coming period are
set. The partners place great emphasis on setting well-designed objectives. They therefore
spend a significant amount of time on this aspect of management. Nevertheless, failure to
meet targets over three periods does lead to dismissal - a small but significant number of
staff have been let go due to underperformance. One of these succeeded in obtaining a

29
sizeable amount of compensation in the USA courts when they sued for breach of
contract.
Despite the jocularity, there is some evidence of real resentments. The Cayman
employees, most of whom were originally UK based, are managed by those partners who
are generally regarded as the most genial, and they also are perceived as having the most
varied and interesting work, and enjoy a better employment package in terms of hours
and holidays, as well as living in a much nicer climate).

COMMERCIAL PERFORMANCE
The traditional equities side of the business has suffered some serious difficulties in the
last three years, and has failed to yield an overall surplus since 1997. The Grand Cayman
operation, involving a variety of business services, has by contrast gone from strength to
strength, and now accounts for over 45% of the profit of the company. There have been
several investigations into potential money laundering cases with Stelling Minnis account
holders, but none has been taken as far as prosecution. The Bank of England, in 2001, did
write to the CEO warning him that they were not sufficiently careful in vetting new
clients at the opening of accounts (a typical point of vulnerability with respect to money
laundering). There was also a US investigative report in a leading east coast newspaper,
suggesting that some Stelling Minnis account holders had connections with terrorist
groups. But again a brief check by the relevant authorities indicated a lack of evidence to
warrant further investigation.

The UK offshore operations continue to be successful. For example, the partners based in
Jersey have chosen to plough back their share of the company profits into the company
last year, and have stated publicly that they will do so again this year if necessary.

POLICIES AND PRACTICES


Alec Stelling devised his own code of practice in the 1950s, and a copy still hangs on the
wall of the main offices. It talks about "..providing fair and informative advice, and
seeking the best opportunities for every customer, large or small." It has been amended

30
and more or less replaced over the years, but the spirit of the current employees' code is
still very much in line with this extract.
There is a strong tradition of democracy and open discussion in the firm. Decisions are
made by the partners after formal consultation with the staff. Formerly, policy proposals
were formulated by the partners in Jersey after telephone fax or telex communication
with their counterparts in Cayman and the other offices. Since 1997 videoconferencing
facilities have been installed in every office, enabling the partners to have
videoconferences at least once a week. Following these, partners will cascade proposals
down to supervisors, who will in turn present these to staff. Feedback is the reverse of
this process. In practice few proposals are rejected by the staff (who after all have very
little formal power in the organization) but on a small number of occasions there has been
significant amendment of a proposal in the light of staff responses. On one occasion there
was a protracted dispute when the partners decided to vary the bonus scheme to reward
high performers more for their individual efforts. Eventually, after an extended
disagreement which led to several administrators threatening to join a union, a
compromise solution was imposed on the employees - the two supposed ringleaders were
dismissed.

There were two cases of whistleblowing in recent years. In one case an employee in the
Isle of Man contacted the local regulating authority when he discovered that senior
managers in the local office had used some of the pension fund money for a high risk
speculative investment in robotics firms. Upon investigation, the senior managers argued
that they had hedged against any major loss by setting up complex offsetting financial
products, and that the proceeds in any case went to the staff, in the form of payments per
voting share. The regulator decided to take no action, but asked that this be specifically
reported on annually. The whistleblower was interviewed by senior management, though
no action was taken at the time. He was, it is true, made redundant for poor performance
about six months later, though there was little that would directly connect that with the
comments made at the time of the disclosure by one senior manager, that "whoever did
this will be on their bike pretty soon". Upon applying to the Isle of Man government, and
then under Human Rights legislation to the mainland UK government, he was informed

31
by both legislatures that as he had benefitted from the advantages of self-employed status,
he could not then try to revert to employed status in order to claim unfair dismissal.

The second case of whistleblowing concerned a young woman in the New York office,
who claimed that the management in New York were using banking as a cover for a
variety of less respectable services for high value clients, such as procuring prostitutes for
visiting businessmen, supplying crack cocaine, and finding various methods of keeping
assets away from the eyes of different tax authorities. This was splashed all over the
leading New York newspapers on the 5th April 2003, though due to other leading news
stories at the time (principally the war in Iraq) it was not followed up by any further
journalistic enquiries. The New York Police Department visited the office and took away
several boxes of materials. Several staff were interviewed, and there was one arrest made,
though after a visit from the senior partner to a leading New York politician (believed to
hold an account with Stelling Minnis) the individual was later released without charge.
The whistleblower soon moved to Grand Cayman, promoted - to the surprise of several
people - to a position of significant responsibility.
Discipline in general is short and sharp. One senior salesman was summarily dismissed
after it was discovered that he had used client funds to carry out share dealings on his
own behalf. His protest that two other sales staff had been let off with a warning the
previous year was not accepted (though it was true). One partner was asked to sell his
share of the company and leave in 2001 when it was reported in the FT that he had failed
to pass on market sensitive information to clients until after he had completed his own
share transactions.

The company received further bad publicity in the Caribbean press in late 2003 when it
was discovered that they had been refusing to appoint local people to jobs in Cayman, in
favor of US and UK staff being seconded to assignments. Given that the workforce itself
was largely non-Caribbean, the local press felt justified in describing Stelling Minnis as a
'closet neo-colonial backwater.' One of the partners, Claire Minnis-Bailey (a niece of
Jonathan Minnis, who founded the Minnis Group) was interviewed on local TV and
defended the company's position, saying "We provide a significant amount of work in
spin-off industries, such as computing and office supplies, so we can hardly be said to

32
avoid the local population" Nevertheless, the company has had significant difficulty in
obtaining basic office supplies locally since then.

THE FUTURE
The company has set its development targets for the next three years:
a) increase by 50% in fee totals the custody and services work
b) develop the office in the City of London
c) expand the fund management business by at least 35% in value

d) re-focus and rationalize the equity trading aspect of the business, eliminating loss
making elements, and producing a clear positive ROI across the whole division

CASE STUDY II : FINANCE CODE OF ETHICS

BUSINESS CONDUCT
PALM Resorts, Delhi Incorporated subscribes to the highest principles of business ethics.
Their common goal must always be to maintain the Company's established reputation for
absolute integrity. PALM does not seek business success through illegal or unethical
means, regardless of the circumstances. Employees whose behavior is found to violate
the Company's Code of Ethics will be subject to disciplinary action including, when
appropriate, termination.

As an PALM employee, you are to follow the highest principles of business ethics. While
it is impossible to define every situation where unethical business conduct may occur, the
following are specifically to be avoided:

• Gratuities to Government Employees/Officials


In accordance with government regulations, no PALM employee may offer a gratuity to
any government employee or official on behalf of, or in pursuance of, Company business.
Gratuities are defined as meals, drinks, gifts, expenses, cash, or any other item of value

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including personal service. An offer to provide, or the actual provision of, any form of
gratuity to a government employee or official will constitute grounds for immediate
termination. This policy does not prohibit offering discounts on food, beverages or
services to governmental employees at PALM facilities, provided such discounts are
offered uniformly to all such employees and do not exceed discount rates offered to other
non-governmental groups. The term "gratuity" does not necessarily include the value or
cost associated with government employees' or officials' participation in or presence for
meals, meetings, conferences, seminars or other events, where such expenditures have
been approved by the Company's senior management in connection with appropriate
interactions with such employees of officials concerning legitimate business, political,
legislative, and/or regulatory activities. The Company may make exceptions to this policy
when, in its sole discretion, it considers such exceptions appropriate.

• Gratuities to/from Customers and Suppliers


As an employee of PALM, you may not offer to give, or accept a gratuity from a
customer, supplier or any other representative in the pursuit of business, or in conjunction
with the negotiation of business on behalf of PALM. Expenses for meals as part of a
seminar, convention, or business meeting are not within the definition of gratuities for the
purpose of this policy. Invitations extended by a customer or supplier to participate in any
program or activity, such as a party or football game, should be referred to their manager
for approval on a case-by-case basis. This policy is not intended to cover normal
gratuities for resort employees for providing service to guests (i.e., food and beverage
services). Any violation of this policy will constitute grounds for immediate termination.
The Company may make exceptions to this policy when, in its sole discretion, it
considers such exceptions appropriate.

• Political Activities
PALM Resorts Incorporated, without reservation, accepts the basic democratic principle
that all employees are free to make their own individual decisions in civic and political
matters.

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However, such activities are to be carried on outside of normal working theirs. No
political activities or solicitations may be carried on within Company premises. For
purposes of this policy, political activities are defined as activities in support of, or in
concert with, any individual candidate (including employees who are or may be
candidates) for political office, or a political party, which seeks to influence the election
of candidates to federal, state or local offices. The term "political activities or
solicitations" does not necessarily include contacts with government employees or
officials at meals, meetings, conferences, seminars, or other events, where such contact
has been approved by the Company's senior management in connection with the
Company's expression of its own views concerning matters that are the subject of
business, political, legislative, and/or regulatory discussion. Nor does this policy apply to
political activities or solicitations undertaken by the Company itself in connection with its
expression of such views. The Company may make exceptions to this policy when, in its
sole discretion, it considers such exceptions appropriate.

RELEVANT LAWS
PALM employees must obey all relevant laws including those that apply to consumer
marketing, privacy, copyright protection, securities and taxes.

CONFLICT OF INTEREST
Employees of PALM Resorts Incorporated may not engage in any activity, practice, or
conduct, which conflicts with, or appears to conflict with, the interest of PALM, its
customers, or its suppliers. Any appearance of a conflict of interest will be deemed as an
actual conflict of interest and is hereby prohibited. As such, employees and their
immediate family may not engage in the same or similar lines of business as those of
PALM nor hold a material financial interest in companies which are competitors to
PALM. For purposes of these provisions, immediate family includes spouse, children and
others sharing the same home as the employee. Exceptions may be made on a case-by-
case basis. Such exception requests must be made in advance of their occurrence to the
employee's supervisor and approved, in writing, by the Human ResTheirce Department.

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Employees are not to engage in, directly or indirectly, either on or off the job, any
conduct, which is disloyal, disruptive, competitive, or damaging to PALM Resorts
Incorporated.

REPORTING
PALM will report the financial condition and results of operations honestly. The
Company's records will be kept in accordance with generally accepted accounting
principles and with established internal control policies. No financial data will be
influenced by others or by performance objectives. PALM will cooperate fully with, and
not conceal information from, external auditors and regulatory agencies during
examinations of the Company's books, records and operations.

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CONCLUSION

Buffeted by the latest scandals in their industry, individuals and firms in the finance and
investment profession sometimes wonder whether their efforts to instill ethics are
worthwhile. In this monograph, I have tried to show that these efforts can be effective if
they are based on sound psychological principles.
Understanding the psychology of ethics is important because this discipline reveals to
us the dynamics involved in ethical decision making—not only on the part of individuals,
as addressed. This knowledge allows us to understand why some investment
professionals behave ethically and others violate ethical (and, perhaps, legal) standards.
This knowledge warns us of situational and social forces that result in otherwise ethical
persons committing clearly unethical deeds. And this knowledge points us in the right
direction for managing the ethical conduct of ourselves, our colleagues, and our
subordinates.
Professionals working in the finance and investment industry are often in situations
where they must decide whether to engage in ethical or unethical behavior. And they are
vulnerable to the temptation to act unethically because of the large sums of money at
stake, the size of the industry and the markets versus their own anonymity as "worker
bees," and their training as economically "rational" strivers after maximum profits (and,
perhaps, their lack of any training in ethics).
The psychological view on what motivates people to be ethical offers insights into
those and other vulnerabilities and introduces the concept of self-actualizing individuals
who are motivated by more than money. They want to live a decent life and carry out
good work. They want to be ethical.
The philosophical approaches to ethical decision making propose ideals of how
people should behave and form a good starting point for our understanding and for
training programs. But the goal is to implement the ideals. So, time and practice are
needed for ethical decision making. And although ethics training may not be able to turn
morally corrupt individuals into saintly professionals, effective ethics education can raise
awareness of ethical concerns and stimulate practice in ethical decision making.

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Along the way, hindering our progress, are the implicit and unconscious biases that
we all carry around. We see ourselves as ethical, and we rationalize our behavior when
we do not act ethically. We may believe that we can do no wrong, so what others call
manipulation is just persuasion. Or we may tell ourselves that we have no power at all, so
we are not at fault. We tend to make snap judgments. We may think we are impervious to
the group's thinking, but psychological studies have shown that most of us are not—that
we need to belong and be accepted by others. Peer pressure and conformity to perceived
authority is alive and well among grown-ups. Awareness of these psychological barriers
to ethical action can help us overcome them.
Knowing the stages of maturity and how these stages affect the ethics of decisions,
we can see where people are along the continuum from self-centered greed to self-
actualization by their actions and statements. Reaching ethical maturity is the goal. The
ethically mature individuals are the people we want in charge. And if we are leaders, that
is the stage we want to reach.

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BIBLIOGRAPHY

BOOKS AND JOURNALS:


 Farrell, H, Farrell, B. J., "The Language of Business Code of Ethics:
Implications of Knowledge and Power", Journal of Business Ethics. 17: 587-601,
1998.
 Kapstein, M., "Business Codes of Multinational Firms: What Do They Say?",
Journal of Business Ethics. 50: 13-31. (2004).
 Singh, Jang B. “A Comparison of the Contents of the Codes of Ethics of
Canada’s Largest Corporations in 1992 and 2003.” Journal of Business Ethics
61:1 (2006)17-29.

INTERNET SOURCES:
 http://www.globalchange.com/businessethics.htm
 http://www.pust.edu/oikonomia/pages/genn/recensione.htm
 http://www.fool.com/personal-finance/general/2006/11/27/financial-planning-
ethics.aspx
 http://www.neurope.eu/articles/90852.php
 http://www.ibe.org.uk/teaching/Ethics%20and%20financial%20services.pdf

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