{"id":396,"date":"2018-11-28T19:33:42","date_gmt":"2018-11-28T19:33:42","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/suny-personalfinance\/?post_type=chapter&p=396"},"modified":"2018-11-28T19:33:42","modified_gmt":"2018-11-28T19:33:42","slug":"14-3-ethics-and-regulation","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-personalfinance\/chapter\/14-3-ethics-and-regulation\/","title":{"raw":"14.3 Ethics and Regulation","rendered":"14.3 Ethics and Regulation"},"content":{"raw":"
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Learning Objectives<\/h3>\r\n
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  1. Discuss the reasons that investing behavior may be unethical.<\/li>\r\n \t
  2. Identify the key professional responsibilities of investment agents.<\/li>\r\n \t
  3. Describe practices that investment agents should pursue or avoid to fulfill their professional responsibilities.<\/li>\r\n \t
  4. Explain how investment agents are regulated.<\/li>\r\n \t
  5. Debate the role of government oversight in the securities industry.<\/li>\r\n<\/ol>\r\n<\/div>\r\n \r\n\r\n<\/div>\r\n

    Financial markets, perhaps more than most, seem to seduce otherwise good citizens into unethical or even illegal behavior. There are several reasons:<\/p>\r\n\r\n

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    1. Investing is a complex, volatile, and unpredictable process, such that the complexity of the process lowers the probability of getting caught.<\/li>\r\n \t
    2. The stakes are high enough and the probability of getting caught is low enough so that the benefits can easily seem to outweigh the costs. The benefits can even blind participants to the costs of getting caught.<\/li>\r\n \t
    3. The complexity of the situation may allow some initial success, and the unethical investor or broker becomes overconfident, encouraging more unethical behavior.<\/li>\r\n \t
    4. Employers may put their employees under pressure to act in the company\u2019s interests rather than clients\u2019 interests.<\/li>\r\n<\/ol>\r\n

      To counteract these realities there are three forces at work: market forces, professional standards, and legal restrictions. But before these topics are discussed, it is useful to review the differences between ethical and unethical, or professional and unprofessional, behaviors in this context.<\/p>\r\n\r\n

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      Professional Ethics<\/h2>\r\n

      Investment intermediaries or agents such as advisors, brokers, and dealers have responsibilities to their clients, their employers, and to the markets. In carrying out these responsibilities, they should demonstrate appropriate professional conduct. Professional conduct is ethical, that is, it is based on moral principles of right and wrong as expressed in the profession\u2019s standards of conduct.<\/p>\r\n

      Brokers and advisors should always deal objectively and fairly with clients, putting clients\u2019 interests before their own. In other words, a broker should always give higher priority to the client\u2019s wealth than to his or her own. When acting on a client\u2019s behalf, a broker should always be aware of the trust that has been placed on him or her and act with prudence<\/strong>[footnote]Acting with sound and responsible judgment; in investing, prudence implies a relative conservatism regarding risk.[\/footnote] and care. The principle of due diligence<\/strong>[footnote]Competent and adequate research into an investment proposal to be able to project its returns and its potential risks.[\/footnote] stipulates, for example, that investment advisors and brokers must investigate and report to the investor every detail of a potential investment.<\/p>\r\n

      Kim receives an order from a client to sell shares because the client believes the stock price will drop. Kim believes the client is right and so decides to sell her own personal shares in that stock as well. She places the order to sell her shares first, so that if the price drops as she sells, her shares will be sold at a higher price. She places the order to sell the client\u2019s shares after the price has dropped. This practice of taking advantage of the client by not putting the client first is called front-running<\/strong>[footnote]An agent trading for its own account before executing trading orders for its clients.[\/footnote]. According to professional ethics, Kim should be putting her client\u2019s interest\u2014and order\u2014ahead of her own.<\/p>\r\n

      Professional ethics call for brokers and advisors to disclose any potential conflicts of interest they may have. They also should be diligent and thorough when researching investments and making recommendations and should have an objective basis for their advice. Investment recommendations should be suitable for the client, and advice should be given with the best interests of the client in mind.<\/p>\r\n

      Shonte is a financial advisor for a large broker-dealer that has acquired a large position in a certain bond issue. It now owns a lot of bonds. Wanting to reduce the company\u2019s exposure to risk from that position, Shonte\u2019s boss suggests that whenever possible, she should advise her clients to add this bond to their portfolios. That way the company can use its clients to buy its bonds and reduce its position. This conduct is unethical, however. Shonte should not automatically recommend the bond to all her clients, because her advice should be based solely on the individual clients\u2019 interests and needs, not the company\u2019s.<\/p>\r\n

      An advisor or broker should<\/p>\r\n\r\n