ethics in the financial services industry
TRANSCRIPT
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Ethics in the Financial Services
Industry
By A.V. Vedpuriswar
(Based on the CFA Institutes code
of ethics)
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Professionalism
Knowledge of the law compliance with applicable laws &
regulations
Independence & Objectivity not accepting gifts, benefits,
compensation that might affect independence and objectivity.
Misrepresentation Need for integrity in areas like
investment analysis, recommendations, etc.
Misconduct Avoiding dishonesty, fraud and deceit.
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Duties to clients
Need to act with prudence, loyalty and care. Place clientsinterests before employer and self interest.
Fair dealing while making investment analysis,
recommendations and taking investment actions.
While in an advisory relationship with clients, investment
recommendations should be made after taking into account
clients investment experience, risk and return objectives.
Investments must be made suitable to the client's financialsituation, and in the context of the client's total portfolio.
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Duties to clients
In case of portfolio management, investment actions mustbe taken that are consistent with the stated objectives and
restraints of the portfolio.
Investment performance information must be fair, accurate
and complete.
Information about clients must be kept confidential unless
the activities are illegal,
disclosure is required by law or
the client permits disclosure.
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Duties to Employers
Exercise loyalty to employer.
Avoid additional compensation/benefits that can lead to
conflict of interest.
Have adequate supervision. Supervisors must anticipate and
prevent violation of rules, laws and regulations.
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Investment analysis, recommendations &
actions
Exercise diligence, independence and thoroughness.
Reasonable and adequate basis, supported by research and
appropriate investigation.
Communication to clients and perspective clients must befair, outlining the general principles underlying the investment
processes.
While presenting investment analysis and recommendations,
fact and opinion should be distinguished.
Records should be kept to support the investment analysis
and recommendations.
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Conflicts of interest
Matters should be disclosed that could lead to conflict of
interest.
Investment transactions for clients and employers must
have priority over investment transactions in which amember or candidate is the beneficial owner.
Disclosure should be made to employers where
compensation or benefits are received for recommending
products and services.
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The CFA membership/candidature
No action allowed that can compromise on the
reputation/integrity of the CFA Institute/ examinations.
Members/candidates must not misrepresent or exaggerate
the meaning/implications of membership of the CFA Institute,holding the CFA designation or candidacy in the CFA
program.
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SECTION 1
Professionalism
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Knowledge of the law
When there is conflict, comply with the more strict law, rule
and regulation.
When there are reasonable grounds to believe that imminent
nor ongoing client/employee activities are illegal, or unethical,analysts should disassociate from such activities.
In special cases, it may be appropriate to disclose violations
to the appropriate government or regulatory authority or the
CFA Institute.
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Independence and Objectivity
Members must reject any offer of gift or entertainment thatcould be expected to threaten their independence and
objectivity.
Members may accept bonuses or gifts from clients but must
disclose this to their employers. The conflicts of interest that arise when research and
investment banking departments collaborate must be
recognised.
Sell side firms must foster a corporate culture thatencourages independence and objectivity and protects
analysts from undue pressure by investment banking
colleagues.
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Independence and Objectivity
Investment banking staff should not be allowed to
approve/disapprove/make changes to research
recommendations.
Issuer paid research is fraught with potential conflicts.
Investors can be led into believing that research appears tobe from an independent source when actually it has been
paid for by the subject company.
Analysts must fully disclose potential conflicts including the
nature of their compensation.
Best practice is to accept only a flat fee for the work prior to
preparing the research report without regard to the report's
conclusions or recommendations.
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Misrepresentation
A misrepresentation is any false statement or omission of a
fact or any statement that is otherwise misleading.
Clients should not be guaranteed specific returns on
investments that are inherently volatile.
Plagiarism in the preparation of material for distribution to
employers, associates, prospects, or the general public, is
prohibited.
Quotations and summaries must be attributed.
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Misconduct
Conduct that reflects poorly on the professional integrity,
reputation, competence of the analyst must be avoided.
Lying, cheating, stealing and other dishonest conduct must
be strictly avoided.
Conduct that damages trustworthiness or competence can
include behaviour that may not be illegal but could negatively
affect the analysts ability to perform their responsibilities.
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SECTION 2
Integrity of capital markets
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What is Material Non Public Information?
Information is non public until it has been disseminated ormade available to the market place in general, as apposed to
a select group of investors.
Members who possess material non public information that
could affect the value of an investment must not act or causeothers to act on the information.
The specificity of the information, the extent of its difference
from public information, its nature and its reliability are key
factors in determining whether a particular piece ofinformation fits the definition of material.
.
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The Mosaic Theory
The less reliable a source, less likely that the information can
be considered material.
The more ambiguous the effect on price, the less material the
information.
The analyst may use significant conclusions derived from the
analysis of public and non material non public information as
the basis for recommendations, even if these conclusions
would have been material inside information had they beendirectly communicated to the analyst by a company.
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Building Chinese walls
To the extent possible, firms should consider the physical
separation of departments and files to prevent the communication ofsensitive information.
The investment banking and corporate finance departments can be
separated from the sales and research departments.
Authorised people should review and approve communicationsbetween departments.
Firms should impose appropriate restrictions on personal trading by
employees and should carefully monitor both proprietary trading
and personal trading by employees.
Firms should require employees to make periodic reports of their
own transactions and transactions made for the benefit of family
members.
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Proprietary trading
A prohibition on all types of proprietary activity when a firmcomes into possession of material non public information is notappropriate.
For example when a firm acts as a market maker, a proprietary
trading prohibition would be counterproductive to the goals tomaintaining the confidentiality of information and market liquidity.
But firms that continue market making activity while inpossession of material non public information should instructtheir market makers to remain passive to the market, that is take
only the contra side of unsolicited customer trades.
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Arbitrage trading
In arbitrage trading, the case for a trading prohibition is
more compelling.
The impetus for arbitrage tradition is neither passive
nor reactive and the potential for illegal profits is
greater.
It may make sense to suspend arbitrage activity when
a security is placed on the watch list.
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Market Manipulation
Members should not engage in practices that distort prices
or artificially inflate trading volume with the intent to mislead
market participants.
Market manipulation can take the form of:
- Misleading transactions
- Dissemination of false or misleading information.
Transactions that artificially distort prices or volume to givethe impression of activity or price movement in a financial
instrument are not allowed.
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Market Manipulation
It is also unethical to secure a controlling, dominant position
in a financial instrument to exploit and manipulate the price of
a related derivative and /or the underlying asset.
Spreading false rumours to induce trading by others is illegal.
This standard is not to prohibit transactions done for tax
purposes or to exploit differences in market power,
information or other market inefficiencies.
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SECTION 3
Duties to Clients
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Loyalty, Prudence & Care
Investment actions must be carried out for the sole benefit of
the client and in a manner the manager believes to be in the
best interest of the client given the known facts and
circumstances
Prudence implies caution and discretion.
Risk and return must be balanced in line with the interests of
the client.
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Fair dealing
Fairly means no discrimination among clients when
disseminating investment recommendations or taking investmentaction.
Members can differentiate their services to clients but different
levels of service must not disadvantage or negatively affect
clients.
The different service levels must be disclosed to clients.
Information should be disseminated in such a manner that all
clients have a fair opportunity to act on every recommendation.All clients must be informed at approximately the same time.
Selective, discriminative disclosure is not allowed.
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Fair dealing
When an investment recommendation changes, greater
caution must be exercised.
While making investments in new/secondary offerings they
should be distributed to all customers for whom investmentrecommendations are appropriate .
Members should not take advantage of their position in the
industry to the detriment of clients.
Compliance procedures must be established to support the
fair treatment of clients.
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Taking precautions
In general, it is a good idea to make reasonable efforts to
limit the number of people who are privy to the fact that arecommendation is going to be disseminated.
Firms must limit the amount of time that elapses between the
time the decision is made to make an investment
recommendation and when it is actually made.
If a detailed report is under preparation, that will take a long
time to publish, an advance summary report might be
published.
People with prior knowledge of an investment
recommendation must not discuss with others or take action
on the pending recommendation.
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Fair dealing
Periodic reviews are recommended to ensue that no client or
customer is being given preferential treatment.
When in an advisory relationship, recommendations should
be made only after a thorough understanding of the clients
risk tolerance, returns objectives and financial constraints.
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Fair dealing
When managing a portfolio according to a specific Mandate,
strategy or style, candidates must make recommendationsthat are consistent with the stated objectives and constraints
of the portfolio.
When communicating investment performance information,
efforts should be made to ensure that it is fair, accurate andcomplete.
Information about past/expected performance must be fair
and complete.
It is unethical to guarantee a rate of return that was
generated in the past.
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Fair dealing
Information about current, former and prospective clientsmust be kept confidential unless:
the information concerns illegal activities on the part of
the client.
disclosure is required by law
the client permits disclosure of the information.
Confidentiality is by and large guided by applicable law.
Confidentiality must be maintained even after the client
relationship has ended.
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SECTION 4
Duties to Employers
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Loyalty
Employees must use their knowledge, skills and abilities for the
benefit of their employer.
They must not divulge confidential information or otherwise causeharm to their employer.
Employees must comply with the policies and procedures
established by their employer unless they conflict with applicablelaws, rules and regulations.
Members should not indulge in an independent competitive activitythat conflicts with the interests of employers without takingpermission.
Members seeking alternative employment must not contact existingor potential clients prior to leaving their employer for the purposes ofsoliciting business for the new employer or take records or fileswithout the written permission of the previous employer.
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Loyalty
But these clients can be contacted as long as the contact
information does not come from the records of the former
employer and there is no violation of any non compete
agreement.
Whistle blowing is permitted when the employer engages in
unethical or illegal activity.
Members must obtain permission from their employer before
accepting compensation or other benefits from third parties
for the services rendered to the employer or for any services
that might create a conflict of interest.
Members should disclose the additional compensation they
receive.
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Supervision
Supervisors must make reasonable effort to detect and prevent
violations of applicable laws, rules, regulations and the code of
Ethics by anyone subject to their supervision or authority.
Compliance procedures must be established and implemented.
The supervisor must decline supervision responsibilities if suchprocedures have not been laid down.
Codes of ethics and compliance policies and procedures must be
distinguished.
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Keep it simple and straightforward
Codes of ethics consist of ethical and fiduciary concepts
based on fundamental principles .
They must be written in plain language and address general
fiduciary concepts, without including numerous detailed
procedures.
Simple straight forward codes of ethics if communicated to
clients can help in conveying the message that the firm in
committed to conducting business in an ethical manner and in
the best interests of the clients.
I l i d i d
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Investment analysis, recommendations and
actions
Diligence, independence and thoroughness must beexercised in analysing investments, making investment
recommendations and taking investment actions.
Analysis and recommendations, must be backed by
appropriate research and investigation.
Clients must be kept informed about the general principles of
the investment processes used to analyse investments,
select securities, construct portfolios.
The factors important while making investment analysis,recommendations and actions must be communicated to
clients.
I t t l i d ti d
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Investment analysis, recommendations and
actions
A distinction must be made between fact and opinion whilepresenting investment analysis and recommendations.
For example, changes in outlook for dividends, earnings
estimates, etc are opinions, not facts.
Records must be kept to support investment analyses.
These records are must not be taken by the employee while
leaving the firm.
It is the responsibility of the firm to ensure that records are
kept.
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Conflicts of Interest
Anything that might affect the objectivity with which the
interests of clients and the employer are safeguarded mustbe disclosed in simple clear language.
Conflicts of interest must be carefully and clearly
communicated.
Requiring members and candidates to disclose all matters
that might impair objectively allows clients to judge motives
and possible biases for themselves.
The most obvious conflicts of interest are relationships
between the members or their firm and issuer
(director/consultant), investment banking, underwriting and
financial relationships, brokers/dealer market making
activities and material beneficial ownership of stock.
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A typical conflict is a members orcandidates ownership of stock incompanies that they recommend to clients.
Sell side members must disclose any materially beneficial
ownership interest in an investment that is being recommended.
Ownership of stock analysed or recommended, participation inoutside boards and financial and other pressures that may influence
a decision must be disclosed to the employer.
Members should disclose special compensation arrangements with
the employer that might conflict with client interests such as
bonuses based on short term performance criteria, commissions,
incentive fees, performance fees and referral fees.
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Investment transactions for clients and employers must havepriority over investment transactions in which a member or
candidate is the beneficial owner.
Family accounts that are client accounts should be treated like any
other firm account and should neither be given special treatment nor
be disadvantaged because of an existing family relationship with theanalyst.
Participation in private placements raises conflict-of-interest issues
that are similar to issues surrounding IPOs.
Investment personnel should not be involved in transactionsincluding private placements that could be perceived as favours or
gifts that seem designed to influence future judgment or to reward
past business deals.
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Some eagerly awaited IPOs may rise significantly in value shortlyafter the issue is bought to market.
Purchase of IPOs by investment personnel create conflict of interest
in two ways:
- Participation in an IPO may have the appearance ofappropriating an attractive investment opportunity from clients for
personal gain.
- Because opportunities to participate in IPOs may be limited,
there may be an appearance that the investment opportunity is
being bestowed as an incentive to make future investment
decisions for the benefit of the party providing the opportunity.
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Members must disclose to their employer, clients any
compensation, consideration or benefit received from of paid
to, others for the recommendation to products or services.
The nature of the consideration flat fee or percentage basis,
one time or continuing benefit based on performance, etc
must also be disclosed.
R ibiliti CFA I tit t b
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Responsibilities as a CFA Institute member
or candidate
Members and candidates must not do anything that
compromises the reputation or integrity of the CFA Institute
or the CFA designation or the CFA examinations.
Members/candidates must not misrepresent or exaggeratethe meaning or implications of membership in CFA Institute,
holding the CFA designation or candidacy in the CFA
program.
The use of the CFA designation must be accompanied by an
accurate explanation of the requirements that have been met
to earn the right to use the designation.
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SECTION 5
Global Investment Performance
Standards (GIPS)
Global In estment Performance Standards
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Global Investment Performance Standards
(GIPS)
GIPS have been framed, taking into account various
misleading practices like:
Representative accounts Selecting a top performing
portfolio to represent the firm's overall investment results for a
specific mandate.
Survivorship bias Presenting an average performance
history that excludes accounts whose poor performance was
weak enough to result in termination of the firm.
Varying time periods Presenting performance for aselected time period during which the mandate produced
excellent returns or outperformed its benchmark making
comparison with otherfirms results impossible.
Global Investment Performance Standards
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Global Investment Performance Standards
(GIPS)
GIPS aim at establishing a standardised industry wide
approach for investment firms to follow in calculating and
reporting their historical investment results to prospective
clients.
They help avoid misrepresentations of performance and to
communicate all relevant information that prospective clientsshould know in order to evaluate past results.
Complying with GIPS is voluntary.
Only investment management firms that actually manageassets, can claim compliance with GIPS.
Compliance is a firm wide process that cannot be achieved
on a single product or composite.
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Composites
One of the key concepts in GIPS is composites.
A composite is an aggregation of discretionary portfolios into
a single group that represents a particular investment
objective or strategy.
The determination of which portfolios to include in the
composite should be done according to pre established
criteria, not after the fact.
This ensures that the firm does not include only the best
performing portfolios in the composite.
Global Investment Performance Standards
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Global Investment Performance Standards
(GIPS)
GIPS covers the following areas:
- Input data
- Calculation methodology
- Composite construction
- Disclosures
- Presentation & reporting
- Real estate
- Private equity