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Learning Objective

8.6.2 Understand the key principles of professional integrity and ethical behaviour in financial services

We are all faced with ethical choices on a regular basis, and doing the right thing is usually obvious.

Yet there have been many situations in the news recently in which seemingly rational people have behaved unethically.

Is this because they consider that there are some situations when ethics apply and others when they do not? Is it because they did not think that their behaviour was unethical? Or maybe it was just that they thought they could get away with it. Or could it be that, in actual fact, it is a bit more complicated and involves all of these thoughts and actions and some more besides?

Despite the strong relationship between the two, ethics should not be seen as a subset of regulation, but as an important topic in its own right.

7.1 Historical Background

The Greek philosophers Socrates, Plato and Aristotle are widely held to be the fathers of modern ethical philosophy, with Aristotle (384^bc–322^bc) being the foremost of these. Aristotle’s thinking is generally described as ‘virtue ethics’, with a central philosophy that requires that individuals actively do good, rather than just being a good person. Aristotle has also been linked to the idea of the ‘natural law’, which suggests that there exists an innate law or coded behaviour which everyone is born with; although this was not a central tenet of his philosophy, the later work of the 12th-century Christian philosopher Thomas Aquinas led to the idea of natural law becoming fundamentally embedded into Christian thinking.

In the 16th, 17th and 18th centuries a number of philosophers developed ethical philosophies; in particular, the work of the German philosopher Immanuel Kant has continued to have a great impact up to the present day. The idea most commonly associated with Kant is the Categorical Imperative, which has been translated as: ‘Act only according to that maxim whereby you can, at the same time, will that it should become a universal law.’ This is sometimes known as the universalisation test, and you may

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unto others as you would have them do unto you.’ A tenet such as this appears in most forms of belief, and it is therefore so widespread that it may be regarded as a societal rather than a religious norm. Kant also elaborates on his argument of the Categorical Imperative by saying that what really counts is one’s intent when doing something, not just doing it out of a sense of duty. ‘When moral worth is at issue, what counts is not actions, which one sees, but those inner principles of actions which one does not see.’

Significant 19th-century figures in the development of ethical thinking include Jeremy Bentham and John Stuart Mill, both of whom were advocates of the ‘utilitarianism’ school, whose overriding principle was that the most ethical decision is the one which will result in the greatest good for the greatest number of people, within reason.

It should not be assumed that philosophy has not carried on into the 20th and 21st centuries. As society has developed, so has moral and ethical thinking, but, until the advent of mass or universal education within the last 100 years, the majority of teaching or leading of the population in these matters was carried out by religious organisations.

Most developed and many undeveloped societies therefore have similar basic tenets in their mores, and these have formed the roots of the norms of society and have been the foundation for much fundamental legislation.

7.2 Ethical or Unethical Practice?

One of the observations sometimes made about ethics is that the benefit of ignoring ethical standards and behaviour far outweighs the benefit of adhering to them, both from an individual and also a corporate perspective.

What this argument ignores is that, while such a policy may make sense and be sustainable for a short period, in our society the inevitable outcome is likely to be at least social and at worst criminal sanctions.

An obvious example is the selling of products that carry a high level of commission for the salesman.

Although there may be benefits to all three parties to the transaction – the product provider (originator), the intermediary (salesman) and the purchaser (customer) – the structure of the process contains a salient feature (high commission) which has the capability to skew the process.

It can be argued that there is nothing wrong with such a structure, which simply reflects an established method of doing business around the world. However, there are fundamental differences in the financial services industry which particularly may affect the relationship between the salesman and the customer. If you buy a car, you can see it, you can try it out and you will discover very quickly whether it performs in the manner advertised and which you expect. You will also be provided, in the case of a new car, with a warranty from the manufacturer. You can thus make your purchase decision with considerable confidence, despite knowing that the reward system in the motor industry means that the salesman will almost certainly receive a commission.

Contrast this with an imaginary financial product. This may be an arena in which you are less than knowledgeable, and the product may be one to which, once committed, you can have no idea about its quality for many years to come, by which time it may be too late to make changes or seek redress.

An ethical salesman should therefore take you through the structure of, say, a long-term investment instrument in such a manner that you may be reasonably assured that you understand what it is and from whom you are buying the product. He should explain the factors which determine the rate of return that is offered, and tell you whether that is an actual rate, or an anticipated rate which is dependent upon certain other things happening, over which the product originator may have no control. He should also tell you what he is being paid if you buy the product.

In other words he will give you all the facts that you need to make an informed decision as to whether you wish to invest. He will be OPEN, HONEST, TRANSPARENT and FAIR.

7.3 An Ethical Corporate Culture

‘Culture’ can be described but not easily defined. Nor can it be imposed in an organisation by just putting in a programme; it must be recognised by those inside who are employed, and by those outside who come into contact with the business. At its most basic, corporate culture expresses itself in behaviour and the way a business is run. Staff are sensitive to management style. When faced with a business problem, a manager has to balance the legitimate requirements of attaining business objectives and the ethical requirements of honesty and integrity in the way this is achieved. If staff see from their managers’ decisions that the prevailing culture is one of trust, integrity and openness, they generally will feel comfortable at work and be proud of the organisation. And this is likely to be reflected in their own dealings with others.

For an ethical culture to be successful, it must have regard to all of those people and organisations who are affected by it. The principal constituents of an organisation and their financial relationships are summarised in the table below.

Stakeholder Financial Relationship

Shareholder Dividends and asset value growth

Provider of finance (lender) Interest and capital repayments

Employee Wages, salary, pensions, bonus, other financial benefits

Customer Payments for goods and services (receipts)

Suppliers Payments for goods and services (invoices)

Community Taxes and excise duties, licence fees

These are all the people, groups and interests with whom a business has a relationship and who thus will be affected by its fundamental ethical values.

8 Example

A builder (supplier) offers a customer an apparent incentive: the frequently seen ‘discount for cash payment’. But what is his primary motivation? While it may be to give the customer a good deal and so to win the business for himself, this is being achieved through the likely under-reporting of his income and thus under-collection of legitimate taxes, both income and VAT.

So what would you do? Would you insist that you will make payment only against a proper invoice, knowing that you will also have to pay VAT? Or would you be willing to compromise your ethical standards, using the argument that what you are doing ‘goes on all the time’.

Would you do that on a business contract at work? Does your company policy allow it? Almost certainly not.

This is a simple example, but in the business context there are numerous other interests to be taken into account when considering who will be affected and in what way. This starts with the smallest participant – you as an individual – and can be followed through to affect all of the stakeholders in the business.

Your actions will affect your team, which may be defined as any colleagues with whom you work, up to the whole business itself depending upon its size. The business will have shareholders and, as a result of your actions improving the profitability of the business, a dividend may be paid that otherwise would not have been paid. So your action will have impacted them, apparently positively. Had you asked them whether they supported your activities, however, knowing what was involved, is it likely that they would have agreed?

And what about the impact upon your external stakeholders: other suppliers and customers who become aware of the standards which your firm has adopted? Are they likely to be reassured?

So what may start out as a well-intentioned but inadequately thought-out action may have consequences which extend far beyond your immediate area.

7.4 The Positive Effects of Ethical Approaches on Corporate Sustainability

Regrettably, we are only too familiar with examples of unethical behaviour having a terminal impact on business, with the names of Enron, Tyco, Worldcom and Parmalat springing readily to mind. Equally, the generally low public regard in which the banking industry is held, as a result of what are perceived to be unethical remuneration practices, provides another salutary example.

One reason for the poor regard that people have for business people and their integrity is that business leaders rarely discuss business values and ethics in public or even in private. As a result, there tends to be reluctance among employees to question decisions of management or raise concerns.

The reticence of leaders to speak up about standards in commercial life may be partly due to uncertainty about the business case for insisting on high ethical standards in business. If a link could be established, therefore, between always doing business responsibly and consistently good financial performance, then there would be more reason for directors of companies to speak up about, and insist on, high ethical standards in their organisations. This includes policy and strategy decisions in the boardroom, and integrity throughout their organisations.

And it is feasible to make such a link.

Research¹ shows more business leaders now understand that ‘the way they do business’ is an important aspect of fulfilling their financial obligations to their stockholders, as well as other stakeholders. They are responding to accusations of poor behavioural standards in various ways.

First, more companies are putting in place corporate responsibility policies or ethics policies, the principal feature of which is a code of ethics/conduct/behaviour to guide their staff. Companies now accept that an ethics policy is one of the essential ingredients of good corporate governance.

Second, modern corporate governance procedures include risk assessments, and until recently these tended to be confined to the financial, legal and safety hazards of the organisation, but growing numbers of companies are recognising reputation and branding issues around lack of integrity as a possible source of future problems. For example, Royal Dutch Shell identifies this among its risk factors in its 2008 Annual Review: ‘An erosion of Shell’s business reputation would adversely impact our licence to operate, our brand, our ability to secure new resources and our financial performance.’

But can the time and effort put into designing and implementing such guidance, including a code of conduct/ethics/practice, be shown to make a difference? Does doing business ethically pay?

Recent studies have provided a positive answer to this question. In 2002–03 the Institute of Business Ethics (IBE) undertook research showing that, for large UK companies, having an ethics policy (a code) operating for at least five years correlated with above-average financial performance based on four measures of value.

The performance of a control cohort of similar companies without an explicit ethics policy – no code – was used for comparison. This was published by IBE in April 2003 under the title ‘Does Business Ethics Pay?’² The methodology developed for this project was used in a more recent study by researchers at Cranfield University and the IBE using more up-to-date data. They came to a similar conclusion.³

So what makes the difference? A pilot study to the Cranfield/IBE report investigated the distinguishing features, if any, of the operations of companies with explicit ethics policies compared with those with a less robust policy.