Ethics in the Financial Services Industry

By A.V. Vedpuriswar (Based on the CFA Institutes code of ethics)

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.

Integrity of capital markets

Material non public information not to be misused Market manipulation to be avoided

Duties to clients
Need to act with prudence, loyalty and care. Place clients interests before employer and self interest. Fair dealing while making investment recommendations and taking investment actions. analysis,

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 financial situation, and in the context of the client's total portfolio.

Duties to clients
In case of portfolio management, investment actions must be 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.

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.

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 be fair, 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.

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 a member or candidate is the beneficial owner.
Disclosure should be made to employers where compensation or benefits are received for recommending products and services.

The CFA membership/candidature

No action allowed that can compromise on reputation/integrity of the CFA Institute/ examinations.

the

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.

SECTION 1
Professionalism

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.

Independence and Objectivity

Members must reject any offer of gift or entertainment that could 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 that encourages independence and objectivity and protects analysts from undue pressure by investment banking colleagues.

Independence and Objectivity

Investment banking staff approve/disapprove/make recommendations. should not changes be to allowed to research

Issuer paid research is fraught with potential conflicts. Investors can be led into believing that research appears to be 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.

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.

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.

SECTION 2
Integrity of capital markets

What is Material Non Public Information?

Information is non public until it has been disseminated or made 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 cause others 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 of information fits the definition of material. .

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 been directly communicated to the analyst by a company.

Building Chinese walls

To the extent possible, firms should consider the physical
separation of departments and files to prevent the communication of sensitive information. The investment banking and corporate finance departments can be separated from the sales and research departments. Authorised people should review and approve communications between 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.

Proprietary trading
A prohibition on all types of proprietary activity when a firm comes into possession of material non public information is not appropriate. For example when a firm acts as a market maker, a proprietary trading prohibition would be counterproductive to the goals to maintaining the confidentiality of information and market liquidity. But firms that continue market making activity while in possession of material non public information should instruct their market makers to remain passive to the market, that is take only the contra side of unsolicited customer trades.

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.

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 give the impression of activity or price movement in a financial instrument are not allowed.

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.

SECTION 3
Duties to Clients

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.

Loyalty, Prudence & Care

The guidelines set out by clients for management of assets must be strictly followed. Investment decisions must be judged in the context of the total portfolio rather than the individual investments within the portfolio. Part of a members duty of loyalty includes voting proxies in an informed and responsible manner.

Fair dealing
Fairly means no discrimination among clients when disseminating investment recommendations or taking investment action. 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.

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 investment recommendations 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.

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 a recommendation 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.

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.

Fair dealing
When managing a portfolio according to a specific Mandate, strategy or style, candidates must make recommendations that 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 and complete. 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.

Fair dealing
Information about current, former and prospective clients must 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.

SECTION 4
Duties to Employers

Loyalty
Employees must use their knowledge, skills and abilities for the
benefit of their employer. They must not divulge confidential information or otherwise cause harm to their employer. Employees must comply with the policies and procedures established by their employer unless they conflict with applicable laws, rules and regulations.

Members should not indulge in an independent competitive activity that conflicts with the interests of employers without taking permission.
Members seeking alternative employment must not contact existing or potential clients prior to leaving their employer for the purposes of soliciting business for the new employer or take records or files without the written permission of the previous employer.

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.

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 such procedures have not been laid down. Codes of ethics and compliance policies and procedures must be distinguished.

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.

Investment analysis, recommendations and actions

Diligence, independence and thoroughness must be exercised in analysing investments, making investment recommendations and taking investment actions. Analysis and recommendations, must appropriate research and investigation. be backed by

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.

Investment analysis, recommendations and actions

A distinction must be made between fact and opinion while presenting 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.

Conflicts of Interest
Anything that might affect the objectivity with which the interests of clients and the employer are safeguarded must be disclosed in simple clear language. Conflicts of interest communicated. must be carefully and clearly

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.

 A typical conflict is a members or candidates ownership of stock in

companies 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 in outside 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.

 Investment transactions for clients and employers must have

priority 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 the analyst. Participation in private placements raises conflict-of-interest issues that are similar to issues surrounding IPOs. Investment personnel should not be involved in transactions including private placements that could be perceived as favours or gifts that seem designed to influence future judgment or to reward past business deals.

 Some eagerly awaited IPOs may rise significantly in value shortly

after 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 of appropriating 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.

 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.

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 exaggerate the 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.

SECTION 5
Global Investment Performance Standards (GIPS)

Global Investment Performance Standards (GIPS)

GIPS have been framed, misleading practices like: taking into account various

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 a selected time period during which the mandate produced excellent returns or outperformed its benchmark making comparison with other firms results impossible.

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 clients should know in order to evaluate past results. Complying with GIPS is voluntary. Only investment management firms that actually manage assets, can claim compliance with GIPS. Compliance is a firm wide process that cannot be achieved on a single product or composite.

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 (GIPS)

GIPS covers the following areas:

Input data
Calculation methodology Composite construction Disclosures Presentation & reporting

Real estate
Private equity