Financial Services- Bhaumik Oza

California Lutheran University

Financial Services• Financial Services consists of Stockbroking, Insurance, Financial Planning, Tax Advising.• Trust and Ethics are the

most important factor in financial services.• Objectionable practices in

financial services are:-1. Deception2. Churning 3. Suitability

• Deception is an act of propagating beliefs in things that are not true, or not the complete truth.

• Clients expect relevant information truthfully in an Understandable, Nonmisleading manner.

• Information is provided in a confusing manner and has a lot of twists.

• Deception creates feelings of betrayal and distrust in the business.

Deception cont’d• Brokers, Agents, Salespersons obfuscate vocabulary

instead of getting to the point of relevance.• A person is deceived when he is misleaded to buy a

less desirable product by false interpretations or a statement which is incomplete in some crucial way.• Salespersons always try to sell their products to the

customers in their self-interest.• Stockbrokers emphasizes clients to invest more by

stating the strengths of the fund and minimizes the weakness.

CASES of Deception Conduct• A brokerage firm buys a block of stock prior to

issuing a research report that contains a “buy” recommendation in order to ensure that enough shares are available to fill customer orders. However, customers are not told that they are buying stock from the firm’s own holdings, and they are charged the current market price plus the standard commission for a trade.

1. What do you think about the stockbroker in this case? Was this a Deception?

2. What Measures could have been taken to resolve such problems?

Case 2• A broker assures a client that an Initial Public Offering (IPO) of a

closed-end fund is sold Without a commission and encourages quick action by saying that after the IPO is sold, subsequent buyers will have to pay a seven percent commission. In fact, a seven percent commission is built into the price of the IPO, and this charge is revealed in the prospectus but will not appear on the settlement statement for the purchase.

1. Did the broker deceived the Clients in buying the Fund?2. Is this activity done by the broker in the interest of getting

commissions?

Churning cont’d• Churning occurs when the broker is given the

complete authority to control the clients account.

• A broker acts on behalf of the clients but is always intended to generate commissions for himself.

• Excessive trading by a broker is disproportionate to the size of account and the clients portfolio.

• Churning often results in substantial losses in the clients account, and even if profitable, may generate tax liabilities for the clients.

Suitability• Brokers, Salespersons and Agents have an obligation to recommend only

suitable securities and financial products.

• These people should provide a reason for believing their recommendation and how it is suitable for the customers.

• The most important factor is to know about the investors portfolio and what investments would be suitable accordingly.

Suitability cont’d• Investments mostly consists of Risk’s which often becomes the

reason for unsuitability for the clients.

• Still Brokers suggest for a few risky investments which can be appropriate in a well-balanced, conservative portfolios.

• Sometimes an aggressive, risk-taking portfolio may also have unsuitable securities if there is not enough return for the compensation of the risk.

• Insider Trading is defined as trading in the stocks of corporation on the basis of material, nonpublic information .• Insider information is typically gained by someone who is

working within or is close to person working in the company . • The market requires certain moral rules and is expected

for moral behavior.• If a person uses insider information to place trades, he or

she can be found guilty of insider trading.• The rules not only suggest the prohibition against fraud

but also concerns with the fairness with the market.• Insider reading can be illegal or legal depending

What is Insider Trading?

Insider Trading• How is Insider Trading Stated?1. the trader has violated some legal duty to a corporation and its

shareholders.2. the source of the information has such a legal duty and the trader

knows that the source is violating that duty.

• What were the Rationales Used to make law on Insider Trading?1. Property Rights.2. Fairness in Information.

United States v. O’Hagan Case• James O ‘Hagan (O) was a law firm partner at firm making an offer for

Pillsbury Company. He was less involved in the transaction from a legal standpoint, but was sufficiently informed to have been aware that purchasing the stock was a lucrative prospect.• O ‘Hagan purchased the stock made a multimillion dollar profit from his

transaction. • The SEC charged O ‘Hagan with a 10b misappropriation of non-public

information (insider trading).• The SEC also charged O with a Rule 14e3(a) violation. This rule requires

a person in possession of material nonpublic information requires to either disclose such information or refrain from purchasing the stock.

Conclusion• Ethics in finance are important for the well being of Finance.

• Ethical misconduct by an individual or a company can be harmful to the society.

• As there is a lot of money involved, it is necessary to develop efficient safeguard to ensure personal and organizational ethics.

• As the law governs most financial activities it is important for ethical leaders and institute to emphasize on the duties of fiduciaries and fairness in trades.