Ethics is about deciding what is right and what is wrong, and applying those principles in our daily lives, including our professional activities.
Most firms have a code of ethics in place in their policies and procedures manual and many reference the CFA Institute's code of ethics.
But beyond policies and procedures, how does your firm deal with ethics in your everyday operations? Is there a tone set from the top by the firm's management that the firm will act ethically and expect all staff to adhere to the code? Is there a way for staff to bring ethical issues to senior management without fear of repercussion?
This section explores ethics in a way that we hope will spur discussion at your firm about ethical behaviour. We hope it also conveys a basic truth: good ethics also equals good business.
Most of the ethics articles and figures cited in this issue have been adapted (with his permission) from a keynote presentation by Robert Rudloff, vice president, internal audit for the MGM Mirage Group, to the Association of Certified Fraud Examiners 2010 conference in Vancouver.
Some Ethical Lapses from the Investment World
- Charles Ponzi gave the world a name for a fraudulent scheme that lives on to this day. Ponzi concocted an arbitrage scheme in Boston, where people would invest in discounted postal reply coupons from overseas, which would be redeemed at face value in the United States. However, there were not enough postal reply coupons to fund the returns promised by Ponzi and ultimately, new investor money was paid out to old investors in order to keep the scheme running. Ponzi had exposure to the basics of this fraud from his time in Montreal working at a bank started by Luigi Zarossi. Zarossi invested in bad real estate loans and paid the interest with the deposits of new accounts. Ponzi spent three years in prison for forging a cheque of a former Zarossi customer, before returning to Boston where he engineered his infamous fraud.
- Bernie Madoff, the perpetrator of the largest investment fraud in the U.S. (using the Ponzi scheme) is now serving a 150-year prison sentence. The total of the fraud, including fabricated gains is estimated at $65 billion, but the actual losses are expected to be $18 billion.
- Norburg Financial Group was the largest investment fraud in Quebec, where Vincent Lacroix diverted $130 million of investors' capital for his personal use.
- Earl Jones ran a $50 million Ponzi scheme in Quebec and defrauded his own family members.
- Enron and WorldCom defined accounting fraud in the U.S., while Canada has Nortel.
- Bre-X, a Canadian penny stock eventually reached $6 billion in market value after reports of a massive gold find in Indonesia. Unfortunately, the gold find turned out to be a massive fraud when technical core samples were found to be salted. Bre-X became the largest mining fraud in history.
Cost of Ethical Lapses
Unethical behaviour can have severe financial consequences, as seen in these high profile examples from the first decade of the 21st Century:
- 2002: Arthur Andersen LLP surrenders it license to practice as Certified Public Accountants in the U.S. after the Enron accounting scandal destroyed its reputation. The effect is the demise of a big five accounting firm and the loss of 85,000 employees around the world.
- 2003: WorldCom agrees to pay $750 million to investors after perpetrating an $11 billion accounting fraud.
- 2005: KPMG pays a settlement of $465 million for promoting what the U.S. government considers to be illegal tax shelters.
- 2008: Siemens pays a $1.6 billion fine to settle bribery allegations by U.S. and European authorities.
- 2010: Goldman Sachs pays a $550 million to settle an SEC allegation that the firm defrauded investors in a mortgage-backed collateralized debt obligation by failing to tell them that hedge fund Paulson & Co., which was planning to bet against the deal, had helped to design it.
- 2014-2017: A forex scandal forced global banks to pay more than $10 billion to settle with regulatory authorities and, individuals are named in criminal proceedings.
While most of the firms listed above are massive and often multinational in business scope, what about for the smaller investment industry firms? For many in the investment industry, the reputation of the firm and individual is paramount and cannot be measured in dollars. Unethical behaviour can tarnish your reputation and cause prospective and existing clients to reconsider your service, which will directly affect your bottom line.
Consider what happened to Arthur Anderson, once one of the big five accounting firms in the world. The firm had its reputation destroyed by the Enron scandal and even in 2010, is the epitome of an unmanageable conflict of interest between its auditing and consulting lines of business.
"I am absolutely not guilty of the charges. There was no criminal intent here. Nothing was hidden. There were no shredded documents. All the information the prosecutors got was directly off the books and records of the company." Dennis Kozlowski
"I know what I don't know. To this day, I don't know technology, and I don't know finance or accounting." Bernie Ebbers
"There are no accounting issues, no trading issues, no reserve issues, no previously unknown problem issues." Ken Lay
"It's fair to say that Kozlowski and Swartz abused many corporate prerogatives and that they invented new ones just so they could abuse them. They acted like pigs, as a lot of CEOs act like pigs." Forbes magazine on Dennis Kozlowski and Mark Swartz
"We don't break the law." Ken Lay
"I just want you to know you aren't going to church with a crook." Bernie Ebbers
"No one will find me to have knowingly committed fraud." Bernie Ebbers
Why Isn't Compliance Enough?
Rules and regulations can only go so far, because:
- the law is the floor,
- the law is constantly changing,
- the law is not necessarily representative of universal morale,
- the law is not always right,
- the law does not answer every challenging dilemma, and
- the law is slow to catch up to new dilemmas.
It's up to firms to establish good ethical behaviour with a proper system of internal controls to deter fraud. Employees rarely miss the ethical issues but employees sometimes don't want to raise the issue, don't have the ability to raise the issue, or fear retaliation for raising the issue.
What Can You Do to Encourage Ethical Behaviour in Your Firm?
- Openness and open lines of communication
- Environment of accountability and personal responsibility
- Freedom for risk-taking within appropriate limits
- Willingness to tolerate and learn from mistakes
- Unquestioned integrity and consistency
- Pursuit of collaboration and integration
- Courage and persistence in the face of difficulty
Ethical Reasoning & Actions
- Issue: Identify the dilemma
- Facts: Obtain all unbiased facts
- Alternatives: What choices do you have?
- Stakeholders: Who has an interest? What are the motivations? Who holds what power?
- Impact: What is the impact on each stakeholder?
- Guidance: Obtain guidance from your organization
- Action: Now what? Take action.
- Monitor outcomes
What Should You Consider and Include for Your Business Ethics?
- The board
- Tone at the top
- Compliance with regulations
- Corporate governance committees
- Auditing and the audit committee
- Human resources
- Strategic planning
- Ethical challenges
- Executive compensation
- Tone at the top
- The CEO
- The board of directors
Corporate Social Responsibility
- Supply Chain
- Labour practices
- Employment practices
- Working conditions
- Health and safety
- Work/life balance
Product & Brand
- Consumer safety
- Intellectual property
- Marketing and sales practices
- Product recall
The Fraud Triangle
Donald Cressey coined the term "fraud triangle" to describe three factors that are present in every fraud:
- Motive or pressure: the need to commit fraud, such as the need for money or the pressure to meet targets and deadlines
- Rationalization: the justification to commit the fraud: the means justify the end; I need the money; the company/client will never miss it
- Opportunity: the situation that enables the fraud to occur, such as poor compliance and weak internal controls
Firms can break the fraud triangle by removing one of the three factors that make up the fraud triangle. The removal of opportunity by instituting a strong compliance system of internal controls is probably the most direct way to reduce and prevent fraud. However, you should still be aware of unusual circumstances, such as an employee suddenly enjoying a lavish lifestyle that is beyond their means.
The Code of Conduct: 20 questions for You to Consider
- One Code for all or two for staff that are more equal than others?
- Does the Code cover newly developing risks?
- Has the Code kept up with changes in the law?
- Can employees raise questions about concerns?
- Do employees certify to the Code?
- Does the Code include examples?
- Is the format inviting and effective?
- Does the Code talk about values?
- Is the Code's organization useful?
- Are there finding aids in the Code?
- Does the Code lead to other information sources?
- Did the Code get the right input?
- Is there a communication plan?
- Has the Code entered the electronic age?
- Does the Code's message reach third parties?
- Is the Code global?
- Is the Code translated if your firm is multilingual or multinational?
- Does the Code include things that no longer make sense?
- Does the Code go to all employees?
- Is the Code ethical and legal?