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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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The role of the fund being to intervene if the Order were to fail in its mission of surveillance over the ethical conduct of its members, this would therefore mean that each chamber would draw up a body of rules and would enforce its members’ compliance with these rules. The rules would be drafted in such a way that they could be referred to directly when sanctions are imposed. The rules would be based on a formal code of ethics.

The code would be drafted by the financial professionals themselves via the representative process, which we believe would in itself serve to strengthen the effectiveness of these standards. In fact, for the citizens of many Western countries today, the law no longer has the same coercive effect as in the past. For the last few years we have witnessed the develTrust and Ethics in Finance opment of what the lawyers call soft law. The increasing sources of law, the complexity of the terms in which legal texts are couched and not least the fact that laws, which in the past applied equally to everyone, now very often only apply to a specific category of people – all these factors combine to make the individual feel less bound by the rule of law.

Under these circumstances, our societies are now relying more and more on the notion of contractual relationships between individuals. A rule that has been agreed under a signed contract therefore carries more weight and, strangely enough, now often seems more binding than the law to which it is subject. So if we want the new financial organisation we desire to create to be as efficient as possible, it would be more appropriate to use a means that can convey to the finance professionals this feeling of contractual choice.

Controls and sanctions

This contractual dimension is necessary but still insufficient to ensure that professionals, of whatever ilk, comply with binding standards.

A code of ethics drafted by a professional Order that has received government authorisation to apply it would enjoy much wider legal force.

This is the model for the code of ethics for the medical profession, for example. Recognised by formal government decree, and enshrined in health and social codes, it forms an integral part of our legal system. For this reason we recommend that the drafting process for the code of ethics for financial professions follow the same logic as the code of medical ethics.

So once the distinct professional chambers have drawn up the code of ethics, the resulting text would be submitted to the authorities, to the Council of State, and finally to the government. Each party would be responsible for checking compliance with regulations and laws already in force, and would have the opportunity to make amendments. Finally the Ethics and Order 91 code would be signed off by the Prime Minister and published in the Journal Officiel (France’s official record of new legislation).

Sanctions imposed by the Order on the basis of the code could go as far as barring a member from exercising his profession or entail measures that would tarnish the reputation of any professionals implicated.

Such effective and occasionally severe sanctions can only be imposed by a “legal person” – the Order in this case – that is directly affected by individuals’ compliance or non-compliance with the code.

A return to order?

It may seem daring to suggest going back to a form of corporatism to help the financial industry recover its balance, given that corporatism was widely used and developed by totalitarian systems and governments with fascist tendencies not so very long ago – in the twentieth century.

And while it may seem easier to set up this kind of model in countries where chambers of stock dealers used to exist once upon a time, it is perhaps these countries that will prove most reluctant to accept reforms perceived as a return to order.

Paradoxically, countries with a more liberal tradition, having greatly suffered from the absence of regulation, might find this solution a persuasive means of both preserving the financial profession and safeguarding the public interest, without any excessive recourse to state intervention. The measures we have put forward are not in the least revolutionary: some have already been proposed and passed into law, while other practical measures have already stood the test of time.

Whatever the fears and apprehensions that arise when the word “corporatism” comes up, we believe that it is possible to impose a form of positive corporatism (to borrow the expression from Professor Gérard Lafay) that would guarantee both the performance and ethical competitiveness of the financial sector – for the greater good of society and of finance professionals as well.



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Australia’s national dictionary defines ethics as “a system of moral principles, by which human actions and proposals may be judged good or bad, or right or wrong”. Other definitions include concepts such as values relating to human conduct, principles of right conduct, rules or standards or a theory of moral values.

Popular understandings of ethics are more likely to include such notions as trust, integrity, honesty, social responsibility and doing the right thing.

Whilst most of us have an understanding of what ethics is, and believe in the importance of ethical conduct in the cooperative functioning of society, difficulty is often met when determining agreed standards of ethical behaviour for the various complex situations in which individuals and organisations find themselves.

It seems that society’s ethical goalposts are constantly shifting and this presents particular challenges to the business world and the finance industry.

94 Trust and Ethics in Finance

Laying the foundation for ethical work cultures

Broadly, the finance industry refers to organisations that deal with the management of money. More specifically, this includes banks, investment banks, insurance companies, credit card companies, stock brokerages, private equity and hedge funds.

Measured by earnings, financial services are the largest industry category in the world. The industry represents 26.1% of the market capitalisation of the Standard & Poor’s Global 1200. Worldwide profits in the publicly quoted banking sector were approximately $100 billion in

2005. Such statistics highlight the significance of the finance industry to the world economy.

By its very nature – involving money – the finance industry and its economic performance is susceptible to quantifiable analysis and measurement. Historically, the success of the finance industry has been judged by profits. Increasingly however, society is seeking to judge the finance industry’s performance and role in society according to broader criteria, such as its social and environmental impact and ethical conduct.

Herein lies the challenge for the finance industry. How does a complex and constantly evolving industry that relies on measurable outcomes to judge performance, satisfy society’s ethical expectations of it?

This is particularly the case when society – itself resistant to cohesive consensus and susceptible to changing social climates – is incapable of articulating what its ethical expectations are.

In 2012 the financial services industry represents 18.4% of the market capitalisation of the Standard & Poor’s Global 1200. This is despite the global financial crisis of the late 2000s which saw a series of corporate collapses including Allco Finance Group and Storm Financial in Australia and Lehman Brothers and Fannie Mae and Freddie Mac in the USA. Again, the response has been largely regulatory with the Dodd-Frank Wall Street Reform and Consumer Protection Act (USA, 2010) and The Bribery Act (UK, 2010). The disparity between CEO and workers pay has also continued with the Occupy Movement adopting the ‘We are the 99%’ slogan in response to the evident and unceasing inequality.

Ethics or Bust 95 What is clear is that the finance industry is currently failing to meet the public’s expectations of ethical conduct. This matters, because the finance industry constantly deals in public and private funds and needs the trust and confidence of the public to do so effectively and efficiently.

As A. Persaud and J. Plender (2007) state: “If the public is to be persuaded of the legitimacy of wealth creation, trust in business and finance has to be rebuilt and a more robust ethical climate established”.

Ethical lapses

Whilst society might find it difficult to define exactly what constitutes ethical behaviour, it seems that ethical lapses are easier to identify.

There has been a range of examples of ethical lapses as the catalyst for significant corporate collapses in the corporate sector since the new millennium, from Enron (US, 2001) to Adelphia (US, 2001), HIH (Australia, 2001), One.Tel (Australia, 2001) WorldCom (US, 2002), Tyco (US, 2002) and Parmalat (Italy, 2003).

Among the ethical lapses experienced by the companies listed above are excessive compensation, misstatements of revenues and operations, improper identification and management of risks, conflicts of interests and fiduciary failure by Board.

The raft of ethical lapses identified as contributing to these and other collapses has served to put corporate behaviour on the public’s radar.

However, despite such high profile cases as Enron, ethical failures continue to plague the corporate sphere and the finance industry is no exception.

In 2004 there was a $360 million foreign currency trading scandal at National Australia Bank, followed by Marsh and McClennan paying $850 million to settle an investigation into bid-rigging that cheated its policy holders, a $100 million settlement by Merrill Lynch for tainted investment advice favouring large investment banks and Morgan Stanley was fined $2.9 million by NASD for trading violations in 2006.

96 Trust and Ethics in Finance

Regulatory response

In response to these ethical lapses we have seen a proliferation of prescriptive legislation, governance codes and compliance measures.

In the United States the Sarbanes-Oxley Act 2002 (SOX) was implemented as well as comprehensive New York Stock Exchange Listing Rules. In the United Kingdom the Tyson Report on Recruitment and Development of Non-Executive Directors (2003) was commissioned and a Combined Code on Corporate Governance 2003 established. Australia responded by implementing CLERP 9 Amendments (2004) and various Corporate Governance Codes. Singapore amended its Companies Act (2002) and revised its Corporate Governance Code in 2005.

There is now a commonly held view, within the finance industry, that the SOX is too prescriptive, to the point that it restricts and stifles the way the industry does business. Already organisations are circumventing these legislative restrictions by re-listing and having their equity capital raised in other locations where they can operate under less draconian regulatory regimes.

Others believe that the regulatory reaction has actually served to exacerbate the problem by creating a risk management culture rather than an ethics based culture. Rather than view regulatory measures as a minimum baseline for governance, it is evident that compliance with corporate governance guidelines is actually the ultimate ethical goal for many organisations (CREDO, 2005).

Whilst regulation of the finance industry by formal regulatory mechanisms (self and government) is essential, it is not enough. Legislation cannot address every possibility and every eventuality of human behaviour, especially considering the complexity of modern business and finance. One thing is known, where there is opportunity, money will find a way to finance it.

Financial products are increasingly difficult to understand, especially in new derivative markets where financial institutions trade in instruEthics or Bust 97 ments such as collateralised debt obligations, credit default swaps, exotic payoff functions and hybrid (multi asset class) securities. These new markets thus pose exceptionally difficult challenges for lawmakers, regulators and gatekeepers such as auditors and rating agencies, who find it hard to keep up with rapid financial innovation.

A comprehensive, constantly developing and responsive regulatory system needs to be one part of corporate governance, with the essential component being a strong ethical foundation. An ethical basis to the operation of finance is not a constraint or limitation on financial agents, but rather the condition that the financial system can exist at all.

The finance industry needs to recognise the shortcomings of legislation and regulation, and acknowledge the complex grey areas where individuals, in both their business and personal lives, have to make difficult decisions that have ethical dimensions.

Persistence of unethical work cultures

Despite an increase in regulation, unethical work cultures persist in the finance industry. Whilst there has been an increase in references to ethical behaviour in company mission statements it is less clear that companies are actually weaving ethical considerations into the day-today conduct of their businesses.

The $360 million foreign currency trading losses at the National Australia Bank (NAB) provide a clear example of this lack of correlation between published statements and actual practice. John Stewart, NAB’s current Managing Director and CEO admits that “while the National had an agreed set of values, people were not held accountable and values were not reflected in the way people were assessed. Culture change programmes were voluntary and there was a lack of visible and consistent leadership in this area. This led to a focus on achieving shortterm profits without regard to the way in which this was done”.

98 Trust and Ethics in Finance Aligning values and culture statements with actual practice is an ethical challenge facing the finance industry. As Australian philosopher Peter Singer (1979) states, “Ethics is not an ideal system which is all very noble but no good in practice. The reverse of this is closer to the truth: an ethical judgment that is no good in practice must suffer from a theoretical defect as well, for the whole point of ethical judgement is to guide practice”.

Conflicts of interest

Various real and perceived conflicts of interest continue to present a challenge for the finance industry. Managing these conflicts to the satisfaction of all stakeholders – employees, shareholders, regulators, customers and the public – is an ethical issue for the industry.

There are many situations and relationships within the finance industry where conflicts of interest have arisen and continue to arise. These


• Independence of non-executive directors (NEDs). NEDs are appointed to protect shareholders where their interests conflict with those of management. However there has been much reporting on the clubby nature of Boards and corporate governance failures despite “independent” NED positions.

• Shareholders interests versus the interests of clients. A company’s obligations to look after their clients’ interests can conflict with the short-term interest of shareholders.

• CEO and Board’s personal interests versus shareholder interests. Recent proposals for management buyouts have met claims of conflicts of interest.

• Auditors can face conflict of interests through various business relationships, institutional structures and incentives that can be seen to impair their objectivity.

Ethics or Bust 99

• Analysts face conflicts of interest when balancing financial promotion with their role of providing independent analysis.

• Private equity deals and leveraged buy-outs give rise to conflicts of interest where senior executives typically increase their stake in a company prior to a takeover.

• Many individuals working within the finance industry face personal conflicts of interest on a daily basis, where they find that their employer and/or the finance industry challenge their personal beliefs or moral values.

Executive remuneration

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