ETH 1 Ethics and Trust in the Investment Profession

Financial markets run on trust, which we can describe as a confident reliance on the dependability of a person or an organization. Savers hand their money to investment managers on the understanding that their interests will be guarded, so a manager who is open, honest, and transparent is worth far more to a client than one who is merely clever. Picture an analyst who publishes reports that hide the real risks of certain companies, hoping to win those companies as banking clients and to earn a larger bonus. The deceit may pay off for a while, but once investors lose money and the story reaches the press, the whole firm loses its reputation, clients leave, and honest colleagues can lose their jobs through no fault of their own. One person can destroy the trust that many people spent years building.

People sometimes assume that acting ethically just means obeying the law. In practice you will meet many situations where no rule tells you exactly what to do, or where the rules that exist are unclear or pull against one another. Responsible professionals have to spot the ethical issue and work out a sound response even when no clear instruction is written down.

What ethics means

Almost every action we take touches other people. A stakeholder is any individual or group with an interest in a decision because the decision could affect them, directly or indirectly. For someone in the investment industry, the list of stakeholders is long: colleagues, clients, the employer, the surrounding community, the profession itself, regulators, and other market participants. A single choice may help some of these groups while harming others, and a choice that looks helpful to a few people in the short run can turn out to harm nearly everyone over a longer horizon.

The word ethics comes from the Greek ethos, meaning character, used for the guiding ideals of a society or group. Ethics is the body of moral principles and conduct rules that guide how we behave. A belief is anything we take to be true; a principle is a foundational belief that anchors a wider system of reasoning; and our beliefs shape our values, the things we judge to have worth. Moral or ethical principles are beliefs about which behavior is good, acceptable, or required and which is bad, unacceptable, or forbidden. They can describe what a person expects of themselves or what a whole community expects of its members.

Behaving ethically means acting on moral principles while weighing your own interest against the direct and indirect effects your actions have on other people. An action counts as beneficial when it improves outcomes for the stakeholders it touches. Telling a client the truth about the costs and risks of an investment is a clear example: it meets what society expects, and it also builds trust and helps the client decide well, which serves the client and the adviser alike. The principles most communities share are familiar ones: honesty, transparency, fairness, diligence, respect for the rights of others, and a sense of justice. Most communities start from these and build a shared set of rules for particular situations.

From shared beliefs to rules, codes, and standards

Governments turn widely held beliefs about right and wrong into laws and regulations, which are conduct rules laid down by a governing authority, whether a legislature or a regulator, for the people and firms it oversees. Because beliefs differ, laws differ too. In some countries an investment adviser is legally bound to act in the client’s best interests, a fiduciary standard: the adviser must understand the client’s goals and risk tolerance, research a range of options, recommend the most suitable one, and keep monitoring it. In other countries the law asks only that a recommendation be suitable, so an adviser may legally recommend a suitable product even when a similar one with lower fees exists. Both can even coexist inside one country, with some advisers held to the higher fiduciary bar and others to the suitability bar.

Smaller communities, such as universities, employers, and professional associations, often write their own beliefs into a code of ethics, a public statement of the group’s values and its general expectations for member behavior. Some groups go further and add standards of conduct, which spell out specific required behaviors. Standards of conduct act as benchmarks for the minimum acceptable behavior of members; members are free to hold themselves to something higher. Joining the community means agreeing to follow its code and standards, and members are usually asked to commit to them in writing, often once a year. When someone breaks the code, the community can suffer reputational damage inside and out, lose trust among its members, and even splinter, which is why groups investigate suspected breaches, repair the harm, and discipline or expel violators.

A profession is an occupational community built on specific education, expert knowledge, and a shared framework of practice and behavior that earns the trust, respect, and recognition of the wider public. Professions have multiplied over the last century as new fields of expertise appeared, pushed along by governments and regulators that want an ethical bond between experts and society, by individuals who see an advantage in being recognized as professionals, and by clients who prefer to deal with them. Doctors, lawyers, actuaries, accountants, architects, and engineers typically combine some licensed status with technical standards. What most clearly separates a profession from an old craft guild or trade body is the duty to uphold high ethical standards, together with a mission to serve society and to set and enforce conduct rules.

How professions build and keep trust

To be credible, a profession has to win the confidence of clients and of society at large. Professions share a group of features that, taken together, make practitioners more trustworthy:

• They normalize practitioner behavior through codes and standards that regulators often recognize and treat as complementary to regulation, since practitioners can codify far more detail than high-level rules can.
• They serve society, urging higher educational and ethical standards and widening access to services; a trusted profession may even earn more freedom to manage its own affairs.
• They are client focused, placing the integrity of the profession and the interests of clients above the practitioner’s own interests, and at a minimum requiring care, skill, and diligence. Providing a high standard of care while acting on behalf of another party is what fiduciary duty means.
• They set high entry standards, signaling that a member offers competence in skill, knowledge, and ethics beyond a paper credential.
• They hold a body of expert knowledge, built by experienced practitioners and shared with all members.
• They require continuing education, since knowledge, technology, ethics, and the legal environment all keep changing; most bodies make a set amount of new learning each year a condition of membership.
• They monitor conduct, holding members accountable through self-regulation and sanctions.
• They are collegial, expecting members to respect one another even while competing.
• They act through recognized oversight bodies, often not-for-profit, that supply education and impose discipline.
• They encourage member engagement, because people follow values they helped shape and because mentoring and volunteering strengthen the profession.

No profession stands still. Greater demands for transparency and public accountability, new technology, and outside review by government or independent bodies all force professions to adapt, and effective ones learn from each other, especially on ethics. Some medical bodies are more than 500 years old yet must still adjust, just like the much younger investment management profession. Society may recognize a field as a profession even before it has met every expectation; as the requirements evolve, gaps appear that take time to close.

Investment management as a profession

Investment management is a relatively young profession, so public understanding of its codes and its recognition by regulators and employers are still catching up. Not everyone in the field is a professional; some have taken no specific training and belong to no professional body, which makes earning broad trust harder because not all practitioners are bound to high ethical standards. Even so, the building blocks have been laid over decades. When Graham and Dodd published Security Analysis in 1934, it marked a milestone in assembling a shared body of investment knowledge, and Benjamin Graham summed up the mindset in The Intelligent Investor in 1949, observing that professionals who succeed at investing stay disciplined and consistent and reflect deeply on both the substance of their work and the way they carry it out. The profession meets most, though not yet all, of the expectations of a profession, and it has grown steadily more global as capital markets have opened, aided by cross-border regulatory coordination and by technology.

Like doctors and lawyers, investment professionals are trusted to draw on a formal body of knowledge and apply it with care and judgment, and they are expected to know more than their clients about finance, technical matters, and the relevant laws. Because clients may not fully grasp the conflicts, risks, and fees involved, the professional must handle and fully disclose those issues in the client’s best interest, guided by care, transparency, and integrity. The profession and investment firms depend on each other to sustain trust, and skilled, ethical practice supports savings, retirement planning, and the efficient allocation of capital across the economy.

CFA Institute as a professional body

CFA Institute is the largest global organization serving investment management professionals. It expanded beyond North America in the 1980s, and in 2015 its Board of Governors resolved to adopt US public company standards and leading not-for-profit practices unless doing so would not serve the membership or the organization. Its declared mission is to lead the investment profession worldwide by championing top standards in ethics, education, and professional excellence, all for the eventual good of society. That mission is backed by the CFA Institute Code of Ethics and Standards of Professional Conduct, which promote the integrity of charterholders and set a model for ethical behavior; candidates and charterholders must meet the highest standard among those set by CFA Institute, regulators, or their employer. Where the interests of clients and of the market conflict, the Code and Standards make the duty to market integrity the overriding obligation.

Acting as a professional body, CFA Institute draws knowledge from working practitioners, administers demanding examinations, and involves members in shaping its codes and values. Its Global Body of Investment Knowledge and Candidate Body of Knowledge are kept current through practice analysis, a continuing process that draws on working professionals so the body of knowledge stays relevant worldwide. Charterholders and candidates must adhere to the Code and Standards and sign a statement of continued adherence each year, and they are expected to maintain and improve their own competence and that of other professionals.

If most professionals already want to do the right thing, why study ethics at all? Because careers throw up unfamiliar situations where the right course is not obvious, or where more than one choice looks acceptable. Studying ethics prepares us for those moments. Failing to recognize the obstacles below can lead to poor decisions and, with them, unintended and unethical outcomes.

Overconfidence in our own morality

The first obstacle is that people tend to believe they are more ethical than average. Everyone cannot be above average, yet surveys keep finding this belief in above-averageness. It is a form of overconfidence, a common behavioral bias in which beliefs and emotions crowd out careful reasoning. Overconfidence makes us overrate the morality of our own behavior, especially in situations we have never faced, and it leads us to lean on internal traits and intentions, along the lines of I am honest and would never lie. Research suggests those internal traits are usually not the main thing that decides whether a person actually behaves ethically in a given moment.

Underestimating situational influences

The second obstacle is underrating situational influences, the external factors such as environmental or cultural pressures that shape how we think and act. Social psychologists have shown that decent people with good intentions can be pushed into unethical acts by a difficult situation, and that even self-styled independent thinkers often bend to social pressure. The bystander effect is one illustration: people are less likely to step into an emergency when others are present. Encouragingly, situations can also nudge people toward better behavior, for instance when they believe someone is watching or when a mirror is placed nearby. The key point is that situational forces are powerful and easy to miss, so learning to notice them is essential.

In the investment industry, money and prestige are constant situational influences. In one experiment, simply calling a game the Wall Street Game rather than the Community Game made participants less cooperative. Large salaries, bonuses, and investment gains can tempt honest, well-meaning people to chase short-term self-interest and overlook the risks and consequences for themselves and others. Loyalty is another strong force: loyalty to a boss, a firm, or fellow employees can lead people to make compromises they would reject in another setting, or would judge harshly in someone else.

Focusing on the short term

The third obstacle is that our minds fasten onto immediate, concrete pressures such as a bonus, a promotion, prestige, or loyalty far more readily than onto long-term goods such as personal integrity and the health of the markets. Situational influences pull the brain’s focus toward the short term, and when decisions turn too narrowly on near-term gains or self-interest, longer-term costs get ignored and ethical lapses become more likely.

Firms often respond with strong compliance programs, which are a good start toward an ethical culture but are not enough on their own. A heavy focus on rules can itself become a situational influence: taken to the extreme, it breeds a check-the-box mentality in which employees start asking what they are permitted to do instead of what they ought to do, and stop weighing the larger picture.

Stakeholders often share the same ethical expectations, but not always; different groups can judge the same act by different criteria. Laws and regulations frequently codify ethical actions that produce better outcomes, for example rules requiring businesses to tell the truth or to make specific written disclosures. Following such a rule is an ethical action and it improves outcomes all round. Consider the disclosure of investment risks required by securities regulators: complying reduces the chance that clients invest without understanding the risks, cuts the risk of complaints and lawsuits if values fall, and lowers the odds of a regulatory investigation or sanction that could damage the reputations of both the adviser and the firm.

Even though laws often reflect ethics, legal and ethical conduct do not always line up. Much behavior is both legal and ethical, but some conduct is one without the other. Some legal activities are viewed as unethical, and some conduct that many people regard as ethical is illegal in certain places. Peaceful protest, an act of civil disobedience, may be a response to a law that people consider unjust: the protest can be seen as ethical even while it breaks a local law. In investing, some countries have no law against trading while holding material nonpublic information, so the trade may be legal there, yet many investment professionals and CFA Institute regard it as unethical. Whistle-blowing, meaning the act of revealing dishonest, corrupt, or unlawful conduct within an organization or government, can likewise breach organizational policy or even local law while striking many people as ethical.

Why law alone cannot guarantee ethics

Some argue that more regulation and monitoring will lift trust in the markets, and sometimes it does, but the law is a limited tool for several reasons. Laws usually follow market practice: regulators may act ahead of a problem or, more often, react after a crisis has already caused losses, and drafting takes time during which the harmful practice can spread. A new law can turn out vague, conflicting, or too narrow, curbing one activity while opening the door to a similar one. Laws also differ across jurisdictions, so a questionable practice can simply relocate to where no relevant rule exists. And laws are open to interpretation, so participants may read them in the most convenient way or delay compliance. For all these reasons, laws and regulations on their own cannot ensure ethical behavior.

Ethical conduct therefore reaches beyond what the law requires and takes in what communities and professional associations regard as right. Acting ethically means thinking through the facts and making good choices even without a clear rule. There is rarely a formula that always yields the ethical answer; ethics calls for judgment, the ability to reach sensible conclusions after genuinely weighing the interests of clients, family, colleagues, employers, and other market participants, and after trying to limit risks, including reputational risk.

Codes of ethics, professional standards, laws, and regulations can all point the way, but individual judgment is the ingredient that turns them into principled choices. When firms build ethics into everyday decisions, they raise both the capacity and the willingness of staff to act well. A robust culture of integrity that senior leaders build and sustain may matter more than anything else in steering people toward ethical behavior, and the wish to do the right thing is reinforced when accountability runs through the workplace.

Adopting a clear code that lays out the firm’s ethical principles is a necessary first step, but a code by itself is not enough. Good intentions are no match for the flood of daily decisions a professional faces, so we have to practice ethical decision-making until it becomes something like muscle memory. Just as coaching and repetition turn a natural ability to run into the technique and endurance to race, teaching and rehearsing ethical decision-making prepares people to handle hard cases when they arrive. Doing so serves individuals, firms, the industry, the markets, and society, because a strong ethical culture wins the trust of investors and supports robust financial markets.

The framework

A useful framework helps a decision maker view a situation from several angles and notice aspects that a narrow, short-term, self-focused view would miss. That wider picture makes a plan of action that harms stakeholders less likely and one that benefits them more likely, and it helps the decision maker explain and justify the choice afterward. Frameworks come in many forms and levels of detail; a general one has four phases:

• Identify: the relevant facts, the stakeholders and the duties owed to each, the ethical principles at play, and any conflicts of interest.
• Consider: the situational influences and personal biases that could sway you, the additional guidance you can seek, and the alternative actions open to you.
• Decide and act.
• Reflect: was the outcome what you expected, and why or why not?

The process runs through these phases but is often iterative, and a decision maker may move among them in a different order. In the identify phase, separate hard facts from opinion and bias, note the information you wish you had, list the stakeholders and your duties to each, pin down the relevant ethical principles and legal requirements, and surface any conflicts, for instance where a duty to a client collides with a duty to an employer. In the consider phase, name the situational influences and biases at work, such as a wish to please a boss or to earn a bonus, and seek guidance from trusted sources who are not caught in the same pressures, from firm policies, and from the CFA Institute Code and Standards; imagining how a role model would act can help. Then decide and act. Afterward, reflect on whether you identified the facts, stakeholders, duties, conflicts, principles, influences, and biases correctly, whether you sought enough guidance, and whether you weighed the alternatives; you may need to reflect more than once as consequences unfold.